Category: Suggested Reading (Page 1 of 2)

Trade Secrets Protection-5 Basic Actions.

Five Tips for Protecting Your Company’s Trade Secrets
by David Barron/ CozenO’Connor

Protecting your trade secrets and proprietary information is a vital part of your business. Every company needs to have policies and agreements in place to prevent employees from stealing property, and wrongfully soliciting your employees and customers when they leave to work for a competitor. Equally important, you must ensure that newly hired employees understand their own obligations to past employers and do not take actions that may unwittingly expose your company to liability.

When hiring a new employee (especially in management or sales), consider including language in the offer letter affirming that the employee has disclosed any restrictive covenants in effect from prior employers, and acknowledging that he/she will not bring any confidential documents, data, or information from previous employers to the company. Such language may protect the company from being sued if a new employee fails to disclose a restrictive covenant, or otherwise engages in a breach of duties owed to a prior employer.

If you are considering hiring a group of employees from a competitor, negotiate with each one separately wherever possible. In many states, employees (especially managers) owe a duty of loyalty to their employer. Acting as a go between or actively soliciting for a competitor while still employed with the prior company could raise legal issues. If you are looking to hire a team or group, it is best to hire the point person first, then once aboard that person can set out to recruit the remaining employees to come to your company (assuming that employee has no contractual restrictions on solicitation).

Develop a protocol for ensuring that high level departing employees do not download or otherwise misappropriate proprietary information. When notified of a resignation: (1) Conduct a review of work email for transmittal of information to personal email accounts; (2) Identify any suspicious use of removable USB devices; and (3) Conduct an exit interview that consists of asking the employee to affirm that all property has been returned, including all electronic devices and passwords.

Handbook policies on confidentiality and the return of company property are appropriate, but a breach of a policy is not actionable, and does not entitle the company to injunctive relief (i.e. an order requiring compliance). Consider requiring a confidentiality agreement for any employees who have access to important company data or property that could be harmful if disclosed to a competitor, and you may want back if not returned.

For key personnel, you may need more than a confidentiality agreement to protect the company’s interests. In those cases, consider the use of a non-compete and/or non-solicitation agreement (which can be coupled with the confidentiality portion into one document). A non-compete provision restricts the employee from working for a competitor for a certain period of time in a defined geographic area. Such covenants must be reasonable, and narrowly tailored to protect the client’s interests. A non-solicitation provision does not restrict the employee from working for a competitor, but restricts certain activities for that competitor, usually soliciting company customers or employees for a period of time. Like a non-compete provision, a non-solicitation covenant must be reasonable. For example, the restriction should only apply to customers with whom the employee actually had contact or access to confidential information, as opposed to a restriction from contacting all of the company’s customers.

Non-compete litigation is state specific and the laws can vary widely from state to state. For example, Texas allows reasonable restraints on competition, while California (and recently Massachusetts) outlaw such agreements. It is advisable to have any agreements reviewed for enforceability in the states where such agreements are likely to be enforced.

THE THREE RULES OF NEGOTIATION.

These three rules of negotiation can mean the difference between your business’s success and failure.


To illustrate the power of these rules, we use the example of a simple negotiation between a small business without apparent leverage and a much larger business with immense leverage. These rules are also highly effective in transactions of much greater complexity and scope, in any industry, and with parties of differing size, interests, needs and challenges.

THE THREE RULES OF NEGOTIATION

Saul Winsten
The Winsten Group.Trusted Counsel LLC
www.thewinstengroup.com

Copyright 2018 Saul Winsten , all rights retained and reserved

These three rules of negotiation can mean the difference between your business’s success and failure.

Contracts are a means to establish and define commercial relationships, increase profitability and reduce risk. These three rules, when properly applied to contract negotiation, also can produce competitive advantage, enduring collaborative relationships, protection of intellectual property rights and business interests, and a wealth of other benefits for your organization.

To illustrate the power of these rules, we use the example of a simple negotiation between a small business without apparent leverage and a much larger business with immense leverage. These rules are also highly effective in transactions of much greater complexity and scope, in any industry, and with parties of differing size, interests, needs and challenges.

Rule One: Start with the End.

Wasn’t it Yogi Berra who said, “If you don’t know where you’re going, you’ll end up somewhere else?” He’s got something there.

Whether problem solving, negotiating a contract or resolving a dispute, you gain a decisive advantage when you begin your negotiation with the end in mind. Then build your strategy and action from there. Not taking the time up front to think through where you need to end up and how you will get there – making it up as you go along – is a mistake too often made.

Our client, a well-established EU-based business with a new USA subsidiary, designs and produces zero-defect, highly engineered products and is a Tier 1 supplier to large multinational manufacturers. It had just been selected by a much larger USA-based multinational Original Equipment Manufacturer (OEM) to negotiate a contract for production and supply of a component for the OEM’s engines. This OEM had earned a reputation for being tough on small suppliers. The OEM enjoyed its size, financial strength and market share, employing that clout in all negotiations. Our client knew that it would be difficult to obtain a profitable contract and retained us to assist in negotiations.

At the beginning of the process, we determined our client’s objectives, our end:
• to obtain a profitable exclusive contract for design and manufacture of highly engineered products in high volume,
• to protect our intellectual property and reduce our risk, and
• to establish and strengthen a new long-term, mutually beneficial relationship with this OEM and its affiliates.

Because our end was to build a productive long-term relationship, we approached negotiations as a collaborative problem-solving exercise, not an adversarial process with a single winner and a single loser. Every piece of correspondence, every interaction between the parties and negotiators, was intended to build trust and confidence.

Next, we identified and assessed our risks and opportunities, and strengths and weaknesses that might impact our ability to obtain the end we sought.

From there we identified our terms:
• what final terms we
needed, and why
• what terms we wanted
• how best to reach our end

Of course, need and want are very different things, not to be confused and never to be lost sight of. What we needed determined what our “walk away” points must be.

Here’s where Yogi comes in. If you don’t know what your objectives are and commit to them from the beginning, you will find yourself in negotiations being pushed or led back from one position to another. The end will be different from the one you hoped for.

Rule Two: Prepare. Prepare. Prepare.

Sun Tzu, the ancient Chinese military strategist and philosopher, said that the true master of the Art of War is one who wins the battle before it has started.

Likewise, the most successful negotiations are those for which careful research and planning begin well before the formal negotiations.

Before sitting down at the negotiating table, it is essential that you thoroughly know and understand the other party, its needs and its goals. Also learn as much as you can about its playbook, the persons with whom you will negotiate and the ultimate decision makers.

When you know yourself and you know your opponent – and apply that knowledge – you gain a significant advantage.

Back to our example:
Prior to our first meeting with the OEM leaders and negotiators, we learned all we could about the other party, its business, its product needs, its sources of competitive product supply, and its processes that might involve our product. Our USA president (an established and knowledgeable engineer), European executives (also established and knowledgeable engineers) and others in the company were in regular contact with the OEM’s engineers and procurement personnel. Through industry knowledge and contacts, we gained more information about the OEM’s negotiators and decision makers, their tactics and demands in similar negotiations, as well as how the OEM treated other suppliers and their intellectual property. And, of course, we carefully reviewed the OEM’s proposed procurement agreement.

When we sat down together, it was apparent the OEM hadn’t expended much effort to learn about us or develop a strategy for this contract. The OEM had bigger deals to think about and was confident that, with its strong leverage, we would accept its demands.

Based on our research, we anticipated that at the very end of negotiations – when we, the smaller party, would happily think the deal was done – the OEM would ask for more.

Because we knew what the OEM had demanded of other suppliers, we anticipated that we would be asked to warehouse our finished product at our sole expense, with payment by the OEM only after it took possession. This consignment arrangement would produce cost savings for the OEM, but it would burden us with additional costs and risk. We also knew the OEM had existing warehousing capacity and financial resources to easily handle its own storage of small components for just-in-time use.

We determined in advance that we would not accept this last-minute demand unless we were adequately compensated. We formulated a response consistent with our advantages (the OEM could not obtain a truly competitive product at this price on this timeline) and what the OEM viewed as our weakness (our size, and eagerness to enter this contract). In this case, we were going to try to turn a perceived weakness into an advantage.

Rule Three: Pay Attention and Seize Opportunity.

Sun Tzu instructed his generals to occupy the field of battle first. In doing so, they could secure the best ground from which to wait for the opposing army’s arrival, watch its moves, and quickly adapt to those moves to achieve victory.

When you apply the first two rules, you may have a better opportunity to occupy the field of battle first. You likely are prepared for engagement before and better than the other party. Thus, you can recognize and utilize favorable opportunities that arise. Some of these opportunities might be subtle, such as cues picked up by the behavior, body language and voice of the other parties.

Turning an opportunity to our advantage:
We arrived for formal negotiations at the OEM’s mammoth headquarters and were ushered into a large conference room dominated by a long, dark table. The OEM had already placed its negotiator, multiple procurement and engineering staff, other assistants, computers and paperwork at their end of the table. We were pointed to seats at the extreme other end. Clearly, the OEM was ready for its traditional adversarial negotiations.

We were prepared to change the dynamics.

We asked to move toward their end of the table, as it would be more conducive to discussion. They agreed. Throughout that day, we worked to create a dynamic of non-adversarial negotiations, of collaborative problem solving.

We already knew a great deal about what the OEM needed to meet its goals and schedules, its current product sourcing, and its supplier challenges. We knew our product capabilities and could calculate our design and production costs to a fraction of a cent. We also had a good idea of the performance, cost and availability of competitive products. With this knowledge, we were able to meet most of the OEM’s demands on terms that also benefitted us, or propose others that were acceptable to us. Our own demands fit the OEM’s budget and were for the most part easily accommodated. Protection of our intellectual property, particularly trade secret information, was crucial for us, and we pressed our requirements until the OEM agreed.

By the end of the second day, the OEM seemed satisfied with the results of negotiations. It now had a reliable supplier of a superior, highly engineered component, in desired volume, at desired cost, with a production and delivery schedule that fit its needs. We, too, were satisfied that the negotiated contract achieved our desired end. It was a classic win-win.

As anticipated, the OEM’s general counsel made the consignment demand after all else had been agreed to. We were prepared. We did not directly reject it, nor we did accept it. Instead, we followed our prepared script. We repeated calmly and deliberately that our product was measurably superior to anything they could procure elsewhere, was at an acceptable price, and would be produced and delivered on a schedule that allowed them to fulfill their customer commitments We used our small size to our advantage, repeating that this new demand would place burdensome costs and risks on us.

Then we said nothing.

Now, you know we wanted that contract. We wanted it signed before we left the OEM’s headquarters. We did not want to risk losing this contract or this new client. In fact, our European chairman and USA president had decided in advance that if push came to shove, the consignment arrangement could be acceptable if we were appropriately compensated. The OEM of course did not know that.

The OEM’s general counsel waited for us to respond. When we did not, he cleared his throat, shifted slightly in his chair, rounded his shoulders a bit and looked down. His voice was softer and of a different pitch when he said, “Well, that’s our final offer.”

It just didn’t look or sound like a final, take-it-or-leave-it demand. It looked like an opportunity for us to seize.

Our company chairman was tired. He began to shift in his seat and was about to speak. He later confirmed that he was about to accept their demand. However, at the last second, he took the cue to wait. He said nothing.

The silence following the “final offer” could not have lasted more than a few seconds. Our chairman thought it seemed longer.

Then the OEM negotiator sighed. “Well, okay. No consignment,” he said.

We all shook hands.

Deal done.

It was the single most profitable agreement ever obtained by our multinational client in its long history.

Saul Winsten is General Counsel of The Winsten Group.Trusted Counsel, LLC a leading legal, strategic and corporate affairs firm. He has served as General Counsel, executive, and trusted outside counsel of US and multinational businesses, non-profit organizations, and strategic alliances. Saul has also served with distinction as a member and leader of Boards of Directors.

*The Three Rules article above was excerpted and adapted from speeches, workshops, and presentations provided to leaders, lawyers, Boards of Directors, senior executive groups, business groups, trade associations and others.

Director Liability And Protection. Developments, Strategies, Trends.

by Pepper Hamilton LLP

Directors and officers are exposed to potential liability from suits by the company, shareholders, and debt holders, among others. There are, however, a number of protections available to protect the assets of directors and officers.

Published in the December 2017 issue of INSIGHTS (Volume 31, Number 12). INSIGHTS is published monthly by Wolters Kluwer, 76 Ninth Avenue, New York, NY 10011. For article reprints, contact Wrights Media at 1.877.652.5295. Reprinted here with permission.

Being a corporate director or officer can be risky business, especially for those involved with public companies. Directors and officers (Ds&Os) are exposed to lawsuits by the company, corporate successors, shareholders, debt holders, employees, bankruptcy trustees and governments. The building blocks of asset protection for Ds&Os are outlined in this article, as well as basic securities and fiduciary liability principles, updates on relevant government enforcement policies under the Trump Administration, and implications for D&O liability insurance coverage.

As discussed here, private securities claims and derivative suits against public company directors and officers are on a powerful upswing, with an unprecedented number of new lawsuits filed in 2017. Meanwhile, under the Trump administration, there are signs of a possible easing of government enforcement actions as the Department of Justice and SEC review prior policies governing corporate cooperation credit and the pursuit of individuals responsible for corporate wrongdoing. In these changing and challenging times, it is important for directors, officers and companies to review their corporate articles, bylaws, contracts and insurance to assure that corporate commitments and policies for protecting Ds&Os fit the needs of the company for balance sheet protection, flexibility and the exercise of discretion, and also satisfy the needs of Ds&Os for reliable and adequate sources of indemnity and advancement.

Asset Protection Overview

Lawsuits and demands against Ds&Os often materialize as claims for alleged violations of securities laws or breaches of fiduciary duties owed to the company or its stockholders. Directors and officers have several potential layers of protection for out-of-pocket expenses and losses, including legal costs, settlements and even judgments.

Statutory Corporate Indemnity and Advancement

State corporations laws permit or require companies to indemnify directors, officers, and employees who are forced to incur costs to defend or protect themselves in lawsuits or proceedings involving their work. Delaware and California law require indemnification of directors and officers who succeed in defending themselves—in Delaware “on the merits or otherwise” and in California “on the merits.”1

Delaware and California law also permit (but do not require) indemnification for defense costs, judgments, fines and settlements incurred by directors, officers and employees who acted “in good faith and in a manner reasonably believed to be in and or not opposed to the best interests of the corporation” or, in a criminal matter, “had no reasonable cause to believe the conduct was unlawful.”2

These are known as the “minimum standards of conduct” for permissive corporate indemnification. A corporation is not legally permitted to indemnify an individual for expenses resulting from conduct that fails to meet these standards. Nor may a corporation indemnify an individual for a judgment of monetary liability to the corporation itself.

Rather than face a potential non-indemnifiable liability, cases against Ds&Os generally settle, if they are not dismissed on pre-trial motions. Corporate laws permit a corporation to advance legal expenses prior to any final determination of whether an individual met the minimum standards of conduct for indemnification. In Delaware and California, corporations may advance defense costs if the individual promises to repay the money if he or she is later found not to have met the minimum standards of conduct for indemnification.3

In order to attract high quality Ds&Os to serve, many companies commit to indemnification and advancement of their Ds&Os in the articles of incorporation or bylaws “to the greatest extent permitted by law.” This language effectively makes permissive indemnification and advancement mandatory.

Contractual Indemnity and Advancement

Directors and officers can strengthen their rights to corporate indemnity and advancement by requiring, as a condition of employment, that the company enter into a private contract stating the terms of its obligation to indemnify and advance.4 Then, if later changes in the articles, bylaws, ownership, key decision-makers or policies are disadvantageous to a director or officer, the company is bound by its contractual agreements to them. These private agreements usually contain presumptions, burdens of proof, timetables and other terms that favor individuals and generally continue in force after the employment relationship or directorship ends.

Exculpation

Many states also permit companies to limit the personal liability of directors (but not of officers) to the corporation and its stockholders with an “exculpation” provision in the articles of incorporation. These provisions excuse directors from personal monetary liability to the company and its shareholders for breach of the fiduciary duty of care. Corporate laws do not permit exculpation, however, for breach of the fiduciary duty of loyalty, bad faith, intentional misconduct, knowing violations of law, transactions resulting in an improper personal benefit, or improper payment of corporate dividends.5

Third-Party Insurance

The final layer of asset protection is D&O liability insurance purchased by the company to protect corporate assets and provide coverage for Ds&Os when the company cannot or will not indemnify them. D&O liability insurance is designed to pay losses (including legal fees) for defending against allegations of “wrongful acts,” such as violations of securities laws or breaches of fiduciary duty, that result in damages to the company, its stockholders or investors.

Most D&O liability policies contain multiple products in a single policy. A traditional “ABC” policy covers personal asset protection and corporate balance sheet protection. Side A covers directors and officers when the corporation cannot or will not indemnify them—such as when it is insolvent, chooses to withhold indemnity, or concludes that an individual failed to meet the minimum standards of conduct. Side B reimburses the corporation for indemnification paid to directors and officers. Side C covers the corporation when it is named in a securities action. Finally, excess Side A DIC (difference in conditions) coverage is dedicated coverage for directors and officers that is not “shared” with the corporation. Side A DIC provides coverage in excess of a tower of primary and excess policies and, among other attributes, “drops down” to replace an underlying insurer if it becomes insolvent.

Although D&O policies provide coverage for claims alleging “wrongful acts,” they exclude coverage for willful or intentional misconduct, which is uninsurable as a matter of law and public policy. That said, insurance can provide coverage for conduct that would not be indemnifiable by the corporation, such as non-exculpable failure of oversight or forms of “bad faith” that do not rise to the level of intentional misconduct. Corporate laws generally allow companies to buy D&O insurance for nonindemnifiable claims.6

Liability Standards—Securities Laws

Corporate directors and officers have potential exposure under both state and federal laws for securities law violations, which commonly are based on allegedly misleading disclosures to investors or illegal sales of securities. Liability for securities violations ranges from mere negligence to intentional wrongdoing. Federal law preempts state law in securities fraud class actions.7

Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) is the work horse most often invoked against directors and officers in private securities litigation. Federal courts have exclusive jurisdiction over Section 10(b) cases, and most federal circuit courts have concluded that “recklessness” satisfies the mental state required to prove liability—although the U.S. Supreme Court has never determined whether “reckless” conduct is sufficient.8

Federal securities fraud class action filings hit a record pace in 2017, with the most new case filings since enactment of the Private Securities Litigation Reform Act of 1995 (PSLRA). The PSLRA set up legal hurdles and protections for companies, directors and officers, designed to weed out meritless claims at the pleading stage, often filed on little more than accusations of prior disclosure fraud when disappointing news results in a stock price decline.9

Sections 11 and 12 of the Securities Act of 1933 (Securities Act) are invoked against Ds&Os less frequently than Section 10(b) because they apply in narrower circumstances.10 Section 11 is designed to redress material misstatements in a registration statement, and most often invoked following a public offering, when stockholders can trace their purchases to a particular registration statement. Section 12 is designed to redress the illegal sale of unregistered securities and material misstatements in prospectuses and other offering materials. Ds&Os can defend themselves against misrepresentation claims under Sections 11 and 12 by demonstrating their due diligence and that they “had no reasonable ground to believe and did not believe” that the challenged statements were untrue when made.11

In 2017, the United States Supreme Court took up an important issue in Cyan Inc. v. Beaver County Employees Retirement Fund,12 about whether state courts have jurisdiction over claims filed under the Securities Act. From the mid-1990’s until recently, plaintiffs brought Section 11 and Section 12 claims in federal court, where many of the PSLRA’s protections operate through the federal rules of civil procedure.13 However, federal courts in California parted company with other jurisdictions by holding that state courts retain jurisdiction over 1933 Act claims. If the Supreme Court agrees, then public companies—especially new companies following an IPO—will face the prospect of securities class actions in state courts that lack familiarity with the federal securities laws and are not obliged to enforce some of the procedural protections contemplated by the PSLRA—thus, increasing D&O liability risk.

Liability Standards—State Fiduciary Duties

The liability of directors and officers for breach of fiduciary duties owed to the corporation or its stockholders is governed by state law—usually the state of incorporation.14 In Delaware, gross negligence violates the fiduciary duty of care.15 In California, directors and officers are held to a standard of ordinary negligence, except that directors, unlike officers, have no liability if they act in good faith and in reasonable reliance on others.16

Duty of Care: The Business Judgment Rule

The first line of defense in a breach of fiduciary duty case is the business judgment rule (BJR). By statute or common law, depending on the state, the BJR immunizes directors for decisions made in good faith and on an informed business basis, even if those decisions result in losses to the company or its stockholders. In Delaware, it is unsettled whether the BJR protects both directors and officers; in California, it protects only directors.17

Many states, including Delaware and California, recognize a presumption that disinterested directors acted in good faith and on an informed basis, and put the burden on plaintiffs to rebut the presumption that the BJR applies to a given board decision.

Where the BJR applies, courts are expected to defer to a board’s decision about managing corporate affairs.18 Even if a board’s business judgment is “substantively wrong, or degrees of wrong extending through ‘stupid’ to ‘egregious’ or ‘irrational,’ ” no court should second-guess it and no director should have liability for it as long as “the process employed was either rational or employed in a good faith effort to advance corporate interests.”19

Business judgments that result in waste of corporate assets, however, are not recognized as valid and could expose directors to personal liability. However, “waste” is a transaction “so one-sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration.”20

Duty of Loyalty and Good Faith

Directors are not entitled to corporate indemnification—nor exculpated from personal liability—for breaches of the duty of loyalty or bad faith. “Bad faith” and the absence of good faith are “two sides of the same coin.”21 Bad faith in its “most extreme form” involves “the conscious doing of a wrong because of [a] dishonest purpose,” or “intentionally fail[ing] to act in the face of a known duty to act, demonstrating a conscious disregard for [his or her] duties.”22 In order to win a money judgment against directors, plaintiffs must allege and prove a non-exculpable breach of the duty of loyalty or bad faith. Accordingly, plaintiffs often allege that directors “consciously disregarded” a duty to intervene in events that are harmful to the company or its stockholders, or that they approved or engaged in transactions for self-interested reasons, knowing that their actions were not in the best interests of the company or its stockholders.

A transaction is self-interested when a director stands on both sides of it or is influenced by someone whose interests are across the table from the corporation’s interests. It is important to note that Ds&Os engage in business transactions with their companies not infrequently. These transactions are not inherently wrongful. Rather, the transaction will be subject to heightened judicial scrutiny, and the burden rests on the self-interested director to prove that the transaction was “entirely fair” to the corporation.23 This heightened scrutiny and burden expose the director to the risk of a finding that the director obtained a personal benefit that he or she knew was opposed to the best interests of the corporation or its shareholders—i.e., non-exculpable, non-indemnifiable conduct.

Liability for Failure of Oversight Under Caremark

Directors also face non-exculpable, non-indemnifiable liability exposure for a failure of corporate oversight that amounts to breach of loyalty. Under the Delaware Court of Chancery’s Caremark decision, directors face liability for breach of loyalty when “a loss eventuates not from a [business] decision but, from unconsidered inaction.”24 Directors may be liable if they knew or should have known that violations of law were occurring within the corporation and yet failed to take steps to prevent or remedy the situation. Directors must assure themselves that “information and reporting systems” exist that are reasonably designed to provide timely and accurate information sufficient to allow them to make informed judgments “concerning both the corporation’s compliance with law and its business performance.”25 “[A] sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish the lack of good faith that is a necessary condition to liability.”26

Because liability under Caremark is based on bad faith amounting to breach of the duty of loyalty, the company cannot indemnify a culpable director or officer. This narrows the potential source of indemnity to D&O insurance. A company may indemnify and advance legal fees and settlement costs, however, before a final determination of liability—which naturally tends to drive failure of oversight cases to settlement.

Government Investigations Focusing on Individual Wrongdoing

The federal titans of securities law enforcement—the Department of Justice (DOJ) and the Securities and Exchange Commission (SEC)—have policies that encourage aggressive pursuit of individuals, both as sources of information and targets of enforcement action. These policies have negative implications for D&O defense.

The DOJ Policy

In a September 2015 memorandum by then-Deputy Attorney General Sally Yates, the DOJ announced a policy to more aggressively pursue individuals.27 This announcement followed an uptick in the number of individuals charged under the Foreign Corrupt Practices Act (FCPA) and the False Claims Act. Statements out of the DOJ under the new administration have raised some uncertainty about whether the policy will continue in full force.

The Yates Memo gave federal prosecutors and investigators guidance on “key steps” to strengthen pursuit of individuals for corporate misconduct. In order to gain “any” credit for cooperation, companies must turn over “all relevant facts” relating to conduct of individuals responsible for corporate misconduct. Both civil and criminal enforcement attorneys are to focus on individuals at the inception of an investigation and share information with each other. Enforcement attorneys may not agree to a settlement that protects individuals or resolves a corporate case without a clear plan to resolve individual cases. Finally, civil attorneys must consider actions for monetary recovery against culpable individuals regardless of ability to pay.

While the impact of the Yates Memo is still playing out, some commentators have noted a counterintuitive drop in FCPA enforcement actions against individuals.28 In a speech at New York University Law School in October 2017, Deputy Attorney General Rosenstein stated that while the Yates Memo is “under review” and subject to change, the policy of focusing on individual accountability for corporation wrongdoing will continue under the current administration.29 On the other hand, in a November 17, 2017 press release, Attorney General Sessions may have been alluding to the Yates Memo in declaring an end to the DOJ “practice” of blurring regulations and “guidance,” stating that the DOJ “will proactively work to rescind existing guidance documents that go too far.”30

The Yates Memo policies of targeting individuals responsible for corporate wrongdoing presents challenges to the protective use of corporate indemnity and third-party insurance. The criteria for obtaining cooperation credit pit companies against directors and officers in positions of oversight. Those potentially in harm’s way will want separate legal counsel early in any internal or government investigation, for which they will look to the company for immediate advancement. Third-party insurance may not be available to defray the cost because coverage generally is triggered by a claim for money and often provides only limited coverage, if any, to cover an investigation.

This dynamic increases the importance of careful consideration of potential conflicts that may require separate counsel for various corporate actors, which can spiral into a full-employment-act for lawyers unless carefully managed. At the same time, companies seeking to curry favor with the government may wish to maximize flexibility to refuse advancement to individuals perceived by the DOJ as potential wrongdoers. Of course, there may be legal limitations on a corporation’s ability to refuse advancement.

The impact of the DOJ’s cooperation program tends to make government investigations more complex, extend over a longer period of time, and foster more tension between and among Ds&Os who are under scrutiny and boards of directors or committees that are leading internal investigations. If an investigation leads to self-reporting of a violation of law, or an enforcement action based on, for example, information provided by a whistleblower, it may take longer for companies to settle while individual culpability remains under consideration. To assess the adequacy of D&O defense and protection, companies should reevaluate their indemnification and advancement bylaws, as well as insurance coverage, retention limits, excess coverage, policy language and exclusions, and Side A coverage for individuals.

SEC Policy

The SEC’s policies of pursuing individuals responsible for corporate securities violations have been endorsed under the Trump administration and raise many of the same challenges discussed above. A more recent SEC policy of requiring companies and individuals to admit wrongdoing in some cases as a condition of settlement further negatively impacts the D&O safety nets of indemnity and insurance.

Pursuit of individuals. SEC initiatives launched in 2010 and 2011 encourage individuals to cooperate and report corporate wrongdoing. The 2010 “Enforcement Cooperation Initiative” offers deferred prosecution agreements and non-prosecution agreements in exchange for cooperation,31 while the 2011 Whistleblower Program, implemented pursuant to the Dodd Frank Wall Street Reform and Consumer Protection Act, provides life-changing bounty awards for tips leading to successful enforcement actions, including against compliance officers and other gatekeepers.32

These programs operate in tandem with the SEC’s longstanding policy of encouraging corporate cooperation with SEC enforcement through self-reporting, self-remediation, and punishing and turning over individuals responsible for corporate wrongdoing. The 2001 Seaboard Guidelines, published in an SEC report of investigation, articulate the framework by which the SEC evaluates corporate cooperation, including factors considered in determining whether, and to what extent, the SEC will grant leniency for cooperating.33

These programs appear to be here to stay under the Trump administration, although details may be tweaked. The Whistleblower Program has continued to generate large rewards. An October 2017 SEC report announced that the total awards under the program have reached $162 million to 47 whistleblowers.34 A co-director of the SEC’s Division of Enforcement recently confirmed that the Seaboard Guidelines also will remain in effect, while acknowledging that the SEC should be more specific about the exact benefits of cooperation and provide greater transparency about why cooperation credit is granted or denied.35

Admissions of wrongdoing. In June 2013, then-SEC Chair Mary Jo White announced a shift in policy to seek more admissions of wrongdoing in settlements—a departure from the SEC’s longstanding practice of permitting settling parties to “neither admit nor deny” wrongdoing. According to a March 2015 article in The New York Times, the SEC had generated admissions of culpability in at least 18 different cases involving 19 companies and 10 individuals. In 2017, however, a co-director of the SEC Enforcement Division stated that, while the SEC supports having companies and individuals that admit wrongdoing to other agencies make similar admissions to the SEC, the “harder piece” is deciding whether to continue a policy of departing from the SEC’s “neither admit nor deny” practice.

The SEC’s policies of pursuing individual wrongdoers and seeking corporate cooperation raise the same issues discussed above regarding the DOJ policies of targeting individuals—i.e., more requests for separate counsel, advancement and indemnification, longer investigations, heightened tension between internal investigators and the subjects of investigation, and greater importance of Side A D&O insurance coverage.

Further, an admission of wrongdoing in an SEC settlement limits the ability of a settling director or officer to access corporate indemnity if the admission is deemed to establish non-indemnifiable conduct. Insurance may not be available to fill the gap because coverage for SEC investigations (as opposed to money damages claims) often is not covered or is limited, and there is no coverage for intentional wrongdoing. Ds&Os who admit liability also risk inability to access corporate or insurance funds for defense in parallel or follow on securities litigation, derivative suits and criminal proceedings.

Corporate D&O Litigation

M&A Lawsuits

Until 2016, whenever a public company was sold, the selling company’s board invariably found itself on the receiving end of a class action lawsuit for breach of fiduciary duty to the selling stockholders. So-called “merger objection” lawsuits typically were filed by stockholders of the selling company claiming that the directors and officers breached their fiduciary duties in negotiating the merger price and terms, agreeing to a price that was too low, and approving deficient proxy disclosures. As of the end of 2014, a leading research firm reported that more than 90 percent of merger and acquisition (M&A) transactions above $100 million had ended up in litigation since 2009.36

Historically, most M&A cases were resolved by settlement before the merger closed based on the defendants’ agreement to make additional disclosures or minor adjustments in the deal terms, along with a negotiated fee to the plaintiff ’s attorneys, in exchange for a broad release of D&O liability. Those settlements, until recently, were routinely approved.37 In these early settlements, directors never face a real prospect of out-of-pocket liability exposure.

Recently, however, more M&A cases are being litigated as traditional class actions for money damages after the merger closes.38 This trend has serious liability implications for directors. In order to obtain a judgment for money damages, plaintiffs must prove non-exculpable conduct. This requires proof of self-dealing, bad faith or breach of the duty of loyalty—all of which expose directors to out-of-pocket, non-indemnifiable loss, leaving directors to rely on Side A insurance to fill a potential corporate indemnity gap. It is often unclear exactly what degree of wrongful conduct, however, may be insured.

Two factors are driving the trend toward post-closing merger class actions. First, the Delaware Court of Chancery has taken a stand against broad releases in exchange for “a peppercorn and a fee,” refusing to approve pre-closing nonmonetary settlements. In January 2016, the Court of Chancery embraced the mounting criticism of these settlements and rejected a disclosure-only settlement in In re Trulia Inc. Securities Litigation.39Trulia echoed the analysis in Acevedo v. Aerofl ex Holding Corp., where the Court of Chancery harshly criticized “disclosure-only” settlements stating that they “do not provide any identifiable much less quantifiable benefit to stockholders” and that “ubiquitous merger litigation is simply a deadweight loss.”40 The Court in Aeroflex gave the plaintiffs three choices: (1) declare the claims moot based on the enhanced disclosures and seek attorneys’ fees; (2) propose a settlement limiting release of the directors to Delaware fiduciary duty claims; or (3) litigate the case.41 None of those choices would provide the defendants with broad releases from personal liability.

Second, the trend toward post-closing merger class action cases is fueled by the high potential dollar recovery. Plaintiffs now are filing many of these cases in federal court (to avoid Delaware).42 Although the cases are subject to a high dismissal rate, the rewards of surviving a motion to dismiss are potentially considerable. But again, in order to win a judgment against corporate directors, plaintiffs must establish non-exculpable liability—such as breach of loyalty—which is not indemnifiable by the company. Individual defendants, who usually have parted ways with the company under new ownership, are highly motivated to encourage a class-wide settlement with insurance dollars rather than face risk of personal liability at trial, even on weak or patently unmeritorious claims.

Derivative Suits

Derivative suits against corporate officers and directors historically have presented a low risk of liability for Ds&Os and low returns for plaintiff’s firms. Generally, cases are filed in the wake of securities class actions and settled for minor prophylactic measures, such as corporate governance improvements, and a relatively small fee award. Recently, however, derivative suits have gained traction after high-profile cases resulted in large settlements, including $275 million for Activision Blizzard (2014), $139 million for News Corp. (2013), $137.5 million for Freeport-McMoRan (2015), and $62.5 million for Bank of America Merrill Lynch (2012), among others.43

Stockholders seeking to sue on behalf of a company must establish their standing to assert the company’s claims, which normally are controlled by the board. Stockholders must first make a demand on the board to bring the desired action, or else establish that demand would be futile because a majority of the directors are too conflicted to exercise valid business judgment on a demand.44 In response to a demand, the board must investigate and make a business decision about whether it is in the best interest of the company to take the action demanded. If the demand is refused, courts should defer to the board’s business judgment and dismiss the case without considering the underlying merits of the claims.45

While the odds that plaintiffs will get past the pleading stage in a derivative suit are low, the potential payoff is high, as the settlements cited above suggest. As in the merger litigation context, plaintiffs must prove that defendant directors engaged in nonexculpable wrongdoing (bad faith, breach of loyalty), which generally cannot be indemnified by the company. Further, companies cannot indemnify directors and officers for a judgment of monetary liability in favor of the company, regardless of the theory. Thus, defendants face theoretical out-of-pocket liability in derivative suits. The primary defense strategy is to obtain dismissal based on plaintiffs’ lack of standing, regardless of the underlying merits of the claim. All equal, a settlement funded by D&O insurance is preferable to trial.

Plaintiffs have gained leverage in derivative suits based on recent Delaware decisions that allow more expansive pre-suit stockholder access to “books and records,” enabling plaintiffs to investigate D&O wrongdoing and file better complaints.46 Delaware courts have long encouraged stockholders to use Section 220 of the Delaware General Corporate Law to obtain nonpublic books and records before bringing derivative actions.47 To obtain corporate records, a would-be stockholder plaintiff need only show a “credible basis from which fiduciary misconduct could be inferred.”48

In 2014, the Delaware Supreme Court upheld a Court of Chancery decision enforcing a “books and records” demand by Wal-Mart stockholders to investigate an ongoing Wal-Mart internal investigation of alleged FCPA violations in Mexico. The court required Wal-Mart to comply with demands to search back-up tapes and to produce lower-level officer documents that were never seen by the board and certain privileged attorney-client communications.49 With such extensive information, plaintiffs in theory are better able to craft derivative complaints that stand a chance of survival at the pleading stage.

Coverage and Indemnity Implications

D&O coverage typically is triggered by a demand for money—not by a demand for corporate “books and records” or a demand that a board of directors investigate and bring suit on behalf of a company. Yet, these demands are serious precursors to derivative litigation against D&O defendants. Some D&O policies provide limited coverage to defray corporate costs of the board’s investigation in response to a demand. But this is only part of the cost. Individual Ds&Os who are questioned in the board investigation may seek separate counsel and request corporate advancement and indemnification. If the derivative suit were to result in a judgment in favor of the company, the culpable Ds&Os could not look to the company to defray the cost, and would need to call upon Side A insurance coverage.

Conclusion

If you are a director or officer of a public company, or considering a board position with a public company, it is a good idea to invest in a legal checkup on the company’s indemnification and advancement articles, bylaws, policies and agreements, and a review of its D&O liability coverage.

Endnotes

1 Del. Gen. Corp. Law § 145(c) (emphasis added); Cal. Corp. Code § 317(d) (emphasis added); Cal. Lab. Code § 2802 (mandating indemnification of employees for expenses incurred in the discharge of lawful duties).

2 Del. Gen. Corp. Law §§ 145(a) and (b); Cal. Corp. Code § 317(b).

3 Del. Gen. Corp. Law § 145(e); Cal. Corp. Code § 317(f).

4 Del. Gen. Corp. Law § 145(f); Cal. Corp. Code §§ 317(g) and (i).

5 Del. Gen. Corp. Law § 102(b)(7); Cal. Corp. Code § 204.

6 Del. Gen. Corp. Law § 145(g); Cal. Corp. Code 317(i).

7 The 1995 Private Securities Litigation Reform Act preempted state securities laws in class actions alleging securities fraud. 15 U.S.C. § 78u-4.

8 Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007).

9 Cornerstone Research, Securities Class Action Filings, 2017 Midyear Assessment, available at https://www.cornerstone.com.

10 Section 11, 15 U.S.C. § 77k; Section 12, 15 U.S.C. § 77l.

11 Section 11(b)(1); 15 U.S.C. § 77k(b)(1); Section 12(a)(2), 15 U.S.C. § 77l(a)(2).

12 Cyan, Inc. v. Beaver County Employees Retirement Fund, Case No. 15-1439.

13 The Securities Litigation Uniform Standards Act of 1998, Pub. L. No. 105-353, 112 Stat. 3227, was designed to preempt state jurisdiction over securities fraud class actions, and was widely understood to apply to claims under the Securities Act of 1933, superseding federal law conferring concurrent state and federal jurisdiction. Compare 15 U.S.C. § 77v with 15 U.S.C. §77(p) (SLUSA).

14 Under the “internal affairs doctrine,” the law of the state of incorporation governs the rights and duties among corporate constituencies. Edgar v. MITE Corp., 457 U.S. 624, 645 (1982). By statute, California law regulates director conduct and other internal affairs of companies that merely do business in the state. Cal. Corp. Code § 2115.

15 Gantler v. Stevens, 965 A.2d 695, 708-09 (Del. 2009).

16 Cal. Corp. Code § 309 (the standard of care is ordinary negligence – action “with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.”). Directors, however, are immune from liability if they act in good faith and in reasonable reliance on others, which is tantamount to a gross negligence standard. Katz v. Chevron Corp., 22 Cal. App. 4th 1352, 1366 (1994).

17 FDIC v. Perry, No. CV 11-5561 ODW (MRWx) (C.D. Cal. Dec. 13, 2011); Gaillard v. Naomasa Co., 208 Cal. App.3d 1250, 1264 (1989).

18 Cal. Corp. Code § 309; Lee v. Insurance Exch., 50 Cal. App. 4th 694 (1996); Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).

19 In re Caremark Int’l Deriv. Litig., 698 A.2d 959, 967 (Del. Ch. 1996) (emphasis in original).

20 In re Walt Disney Co. Deriv. Litig., 906 A.2d 27, 74 (Del. 2006); see also In re Walt Disney Co. Derivative Litigation, 907 A.2d 693, 749 (Del. Ch. 2005) (“waste is very rarely found in Delaware courts … . committing waste is an act of bad faith”).

21 In re Dole Food Co. Stockholder Litig., 2015 Del. Ch. LEXIS 223, at *129 (Aug. 27, 2015).

22 Id. at *129-30 (quoting McGowan v. Ferro, 859 A.2d 1012, 1036 (Del. Ch. 2004)).

23 See Guth v. Loft, 5 A.2d 503, 510 (Del. Ch. 1939).

24 In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959, 967-968 (Del. Ch. 1996); see also Stone v. Ritter, 911 A.2d 362, 365 (Del. 2006) (confirming that “Caremark articulates the necessary conditions for assessing director oversight liability”).

25 Caremark, 698 A.2d at 970.

26 Id. at 971.

27 Sally Quillian Yates, Individual Accountability for Corporate Wrongdoing, Dep’t of Justice, available at http://www.justice.gov/dag/file/769036/download.

28 Sharon Oded, “Yates Memo – Time for Reassessment?,” Compliance and Enforcement, available at https://wp.nyu.edu/compliance_enforcement/2017/04/20/yates-memo-time-for-reassessment/#_edn4.

29 Kevin LaCroix, “Deputy AG Emphasizes Continued Individual Accountability for Corporate Misconduct,” D&O Diary blog, October 31, 2017 available at https://www.dandodiary.com/2017/10/articles/director-andofficer-liability/deputy-ag-emphasizes-continuedindividual-accountability-corporate-misconduct/.

30 Attorney General Jeff Sessions Ends the Department’s Practice of Regulation by Guidance, press release (Nov. 17, 2017), available at https://www.justice.gov.

31 SEC Spotlight, “Enforcement Cooperation Program,” available at https://www.sec.gov/spotlight/enforcementcooperation-initiative.shtml.

32 The SEC’s website announces huge awards. https://www.sec.gov/spotlight/whistleblower-awards. See https://www.sec.gov/spotlight/dodd-frank/whistleblower.shtml (background of the Whistleblower program).

33 Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on the Relationship of Cooperation to Agency Enforcement Decisions, https://www.sec.gov/litigation/investreport/34-4969.htm.

34 SEC Press Release, October 12, 2017, available at https://www.sec.gov/news/press-release/2017-195.

35 Andrew Ramonas, “SEC Should Clarify Path to Cooperation Perks in Cases: Official,” Bloomberg BNA, Oct. 26, 2017, available at https://www.bna.com/sec-clarify-path-n73014471401/.

36 Cornerstone Research, Shareholder Litigation Involving Acquisitions of Public Companies, Review of 2014 M&A Litigation, at 1, available at https://www.cornerstone.com [“2014 M&A Litigation”].

37 Acevedo v. Aeroflex Holding Corp., C.A. No. 7930-VCL, transcript of settlement hearing at 63-65, July 8, 2015 (Laster, V.C.) (quoting Solomon v. Pathé Communications Corp., 1995 Del. Ch. LEXIS 46, C.A. No. 12,563 (Del. Ch. Apr. 21, 1995) (Allen, C.)).

38 2014 M&A Litigation, supra note 37, at 1.

39 In re Truvia Inc. Sec. Lit., 129 A.3d 884 (2016).

40 Acevedo v. Aeroflex Holding Corp., No. 7930-CVL, at 63-65 (transcript of settlement hearing).

41 Id. at 74-76.

42 Cornerstone Research, Securities Class Action Filings, 2016 Year in Review, at 11-12, available at https://www.cornerstone.com.

43 See Kevin LaCroix, Largest Derivative Lawsuit Settlements, D&O Diary blog, Dec. 5, 2014, available at http://www.dandodiary.com/2014/12/articles/shareholdersderivative-litigation/largest-derivative-lawsuitsettlements.

44 See Aronson v. Lewis, 473 A.2d 805, 818 (Del. 1984) (holding that a stockholder may pursue a derivative suit in the absence of a pre-suit demand on the corporation’s board of directors only if the stockholder’s complaint contains allegations of fact sufficient to create a reasonable doubt (1) that the directors are disinterested and independent or (2) that the challenged transaction was otherwise the product of valid business judgment).

45 See, e.g., Cuker v. Mikalauskas, 692 A.2d 1042, 1045 (Pa. 1997) (the BJR permits the board of directors of a Pennsylvania corporation to reject a demand or terminate a derivative suit brought by the corporation’s stockholders); Zapata Corp. v. Maldonado, 430 A.2d 779, 788 (Del. 1981) (describing standard and proceedings in Delaware for dismissal of derivative claims based on the business judgment of an independent committee).

46 For example, the court in King v. VeriFone Holdings, Inc., 12 A.3d 1140 (Del. 2011), enforced an inspection demand under Delaware General Corporate Law section 220 in order to enable stockholders to take discovery and file a better derivative complaint after the first was dismissed for failure to plead that a pre-suit demand on the board would have been futile.

47 VeriFone Holdings, 12 A.3d at 1150 n.64 (citing cases).

48 Polygon Global Opportunities Master Fund v. W. Corp., 2006 Del. Ch. LEXIS 179 (Oct. 12, 2006).

49 Walmart v. IBEW, No. 13-614 (Del. July 23, 2014).

Employee Non-Disclosure Agreements and Enforcement.

Drafting and enforcing NDAs requires considerable thought, care, continual maintenance and a skilled legal advisor. It is an area rife with risks and traps; and employers who believe they can “gag” their employees, by simply requiring them to sign a broadly worded agreement with heavy penalties, may be in for a rude shock.

How Weak Are Employee “Nondisclosure Agreements”? The Answer May Make You Gag

Gregory W. McClune
POSTED BY GREGORY W. MCCLUNE ON 30 MAY 2017
POSTED IN NONDISCLOSURE AGREEMENTS, Foley and Lardner
Background
We live in a world of “leaking” and threats of dire consequences for the leakers. Does an employer have the legal means to prevent disclosure of information acquired during employment? Likewise, can an employer seek legal redress for such disclosures?

In late 2016, the Virginia-based political journalism company, Politico, published an article revealing that the Trump Transition team had required all its “members” (presumably including its employees) to sign a “non-disclosure agreement” (NDA) “to make certain they keep all of their work confidential.” According to the article, such agreements were standard in the Trump organization. The article stated that the NDA prohibited an employee or volunteer from “disclosing info about major portions of the transition work, like policy briefings, personnel material, donor info, fundraising goals, budgets, contracts, or any draft research papers. It also demands that if anyone on the team suspects a colleague of leaking material, he or she must tell transition team leadership. And it gives the Trump team grounds to [fire] those who run afoul of the rules.” (A mandatory “snitch” clause?)

Would such an agreement be enforceable against an employee or volunteer? We will answer that question at the end of this article.

Drafting and enforcing NDAs requires considerable thought, care, continual maintenance and a skilled legal advisor. It is an area rife with risks and traps; and employers who believe they can “gag” their employees, by simply requiring them to sign a broadly worded agreement with heavy penalties, may be in for a rude shock.

The problems are many. First, this is an area that is primarily enforced by state law, and the states are far from uniform in viewing the enforceability of NDAs. Thus, a non-disclosure provision enforceable in one state may be struck down in another. Employers who operate in multiple states will have to ensure it is compliant with the laws of all those jurisdictions.

Most jurisdictions will decline to enforce an overbroad definition of “confidential information.” To that end, an Illinois court refused to enforce an NDA that sought to protect against the disclosure of information concerning “any methods and manners by which Employer leases, rents, sells, finances, or deals with its products and its customers.” (Trailer Leasing Co. v. Associates Commercial Corp., 1996 WL 392135, at *1 (N.D.Ill. July 10, 1996)).

Similarly, an employer’s attempt to seal an employee’s lips forever will find little sympathy in the courts. A Virginia court invalidated an NDA on two grounds. It found that the employer had attempted to preclude an employee from disclosing any information concerning the business of the employer to any person. Thus, the prohibition was “not narrowly tailored to protect the legitimate business interests” of the employer. The court explained that the provision was so overbroad that, as written, it prohibited the employee from telling a neighbor anything about the employer – including information that was not proprietary in nature or worthy of confidence – for the rest of her life. (Lasership, Inc. v. Belinda Watson and Midnite Air Corp., d/b/a Midnite Express, 79 Va. Cir. 205 (1979)).

Some state courts (e.g., Georgia, New York, and Illinois) may “blue pencil” a defective agreement; that is, excise the offending provisions and allow the remainder of the agreement to be enforced. But even if an employer finds itself in one of those jurisdictions, there is no guarantee the judge will undertake that exercise as he/she may find the offending portion key to the whole agreement and, therefore, strike the entire NDA.

Recently a court in North Carolina invalidated an NDA on a different basis that, if followed by other courts, could have far-reaching consequences. The court invalidated the entire NDA because there was no additional “consideration” (i.e. the employee gave up his/her rights but received no additional compensation or other item of value). (Roundpoint Mortgage Co. v. Florez, 2016 NCBC 17 (Feb. 18, 2016)).

There are yet other traps for the unwary. This year a federal appeals court struck down a “confidentiality agreement” that sought to preclude an employee from sharing “private employee information (such as salaries, disciplinary action, etc.)“ because the restriction unlawfully impinged on the employees’ rights, under Section 7 of the National Labor Relations Act, to discuss such matters. (Banner Health System v. N.L.R.B., 2017 WL 1101104 (D.C. Cir. 2017)).

Finally, even if an employer crafts a compliant NDA it will lose its power to enforce the NDA if it is lax in the treatment of confidential information. A written agreement does not supplant the need for sound business practices which safeguard such secrets and prevent disclosure. Moreover, an employer will enhance its chance of enforcing an NDA by periodically reinforcing the need for confidentiality, conducting regular training on the proper handling of confidential information, etc.

So, back to the Trump transition team and its NDA; would that have been enforceable? We have not had access to the full agreement so we are not in a position to be definitive. However, we are mindful of that old story about a physician coming across a victim lying on a public sidewalk. When asked by a bystander in the gathering crowd how the victim was doing, the physician, after a brief examination, responded: “Well, only two of the wounds are fatal; the others aren’t so bad.”

BOARD OVERSIGHT OF CORPORATION COMPLIANCE PROGRAMS: RECENT DOJ GUIDANCE AND WHAT TO DO NOW

BOARD OVERSIGHT OF CORPORATION COMPLIANCE PROGRAMS: RECENT DOJ GUIDANCE AND WHAT TO DO NOW
By Holly J. Gregory* and Rebecca Grapsas*

Boards should consider assessing the effectiveness of their compliance programs now in light of the DOJ’s recent guidance on evaluating compliance programs — whether or not the company currently has any compliance issues.

Each company should, at a minimum, have a basic effective compliance program in place. A program that exists “on paper” but is not effective is not sufficient. As well as making good business sense for a range of reasons, having an effective compliance program can influence a federal prosecutor’s decision on whether to charge a company for the bad acts of its employees or officers and the extent to which the company may receive credit for cooperation in a settlement. Having an effective compliance program can also help mitigate penalties if corporate wrongdoing is found

Oversight of a company’s “tone at the top” and its compliance program designed to establish and maintain that tone and detect problems is an important board responsibility.As fiduciaries, directors are required to assess the company’s compliance program in light of the legal and regulatory compliance framework and ensure that the company has appropriate compliance-related reporting and information systems and internal controls in place. It is a business judgment for the board to determine what compliance program best suits the company’s needs and the level of compliance risk it is willing to take.

Each company should, at a minimum, have a basic effective compliance program in place. A program that exists “on paper” but is not effective is not sufficient As well as making good business sense for a range of reasons, having an effective compliance program can influence a federal prosecutor’s decision on whether to charge a company for the bad acts of its employees or of cers and the extent to which the company may receive credit for cooperation in a settlement. Having an effective compliance program can also help mitigate penalties if corporate wrongdoing is found

The standard for effectiveness in compliance program design is set forth in Chapter 8 of the United States Federal Sentencing Guidelines, which provides that a company must:

Establish standards and procedures to prevent and detect criminal conduct

Ensure board oversight of the compliance program

Appoint a high-level individual (such as a chief compliance of cer) who has overall responsibility for the compliance program

Exercise due diligence to exclude unethical individuals from positions of authority

Communicate information about the compliance program to employees and directors

Monitor the compliance program’s effectiveness

Promote and consistently enforce the compliance program

Respond to violations and make necessary modi cations to the compliance program (US Sentencing Commission Guidelines Manual §§ 8B21(b), 8C25(f))

The Principles of Federal Prosecution of Business Organizations in the US Attorneys’ Manual provide that prosecutors should consider specific factors (known as the “Filip Factors”) in conducting corporate investigations, determining whether to bring charges and negotiating plea or other agreements. These factors include “the existence and effectiveness of the corporation’s pre-existing compliance program” and the corporation’s remedial efforts “to implement an effective corporate compliance program or to improve an existing one.” The Department of Justice (DOJ) emphasizes that critical factors in evaluating a compliance program are “whether the program is adequately designed for maximum effectiveness in preventing and detecting wrongdoing by employees and whether corporate management is enforcing the program or is tacitly encouraging or pressuring employees to engage in misconduct to achieve business objectives” US Attorneys’ Manual § 9-28.300, General Principle; § 9-28.800, Comment (2015)

In February 2017, the Fraud Section of the DOJ issued a resource entitled Evaluation of Corporate Compliance Programs. The document provides more speci c examples of how federal prosecutors will evaluate a company’s compliance program in the process of

The DOJ’s recent guidance for evaluating corporate compliance programs is also discussed in the most recent issue of Sidley’s Anti-Corruption Quarterly.

investigating and resolving an enforcement matter. The document emphasizes that “the Fraud Section does not use any rigid formula to assess the effectiveness of corporate compliance programs.” The document is the latest communication forming part of the Fraud Section’s Compliance Initiative, which began with the Fraud Section’s hiring of Hui Chen as full-time compliance counsel in November 2015.

The document contains probing questions regarding the following eleven “sample” topics:

1. Analysis and remediation of underlying misconduct (including root cause analysis and prior indications)

2. Senior and middle management (including conduct at the top, shared commitment and oversight)

3. Autonomy and resources (including compliance function stature, experience, quali cations, empowerment, funding and outsourcing)

4. Policies and procedures (including design, applicability, gatekeepers, accessibility, operational integration, controls and vendor management)

5. Risk assessment (including methodology, information gathering and analysis, and manifested risks)

6. Training and communications (including form, content and effectiveness, communications about misconduct and availability of guidance)

7. Confidential reporting and investigation (including reporting mechanism effectiveness, investigation scope and response to investigations)

8. Incentives and disciplinary measures (including accountability, process and consistency)

9. Continuous improvement, periodic testing and review (including internal audit, control testing, interviews and evolving updates)

10. Third-party management (including risk-based and integrated processes, controls, relationship management and misconduct consequences)

11. Mergers and acquisitions (including due diligence process, integration in the M&A process and process connecting due diligence to implementation)

The questions are designed to look behind a company’s compliance program “on paper” and evaluate how the program has been implemented, updated and enforced in practice. Although some of the questions focus on the effectiveness of a company’s compliance program in the context of specific misconduct (for example, what caused the misconduct, whether there were prior indications of the misconduct and which controls failed), many of the questions focus on the compliance program more broadly, including, for example, whether compliance personnel report directly to the board, what methodology the company uses to identify, analyze and address the risks it faces, and how the company incentivizes compliance and ethical behavior.

Compliance program assessment is a key element of the board’s oversight of compliance programs. Boards should conduct such assessments periodically to identify areas for improvement in light of the company’s evolving risks and regulatory preferences with respect to compliance structures and practices. Periodic assessment of the compliance program, in a process overseen by the board or a board committee, helps ensure that the program continues to be “ for the purpose” by identifying areas for improvement, while also creating evidence of the company’s commitment to compliance for use in any future regulatory enforcement actions. Assessments should be risk-based to re ect the company’s changing risk environment and to help ensure that limited compliance resources are prioritized to focus on the most signi cant risks.

The assessment criteria should be based on the elements of an effective compliance program as described in DOJ guidance discussed above, including specific guidance from
regulators regarding the company’s industry. The assessment criteria should also reflect trends in settlement agreements, developing notions of recommended practices (both generally and within the company’s specific industry), and the practices of peer companies, to the extent that benchmarking data is available.

In conducting its assessment, the board should evaluate the following and consider how it would answer the specific questions set forth in the DOJ’s recent guidance:

■ The board’s level of oversight including availability of compliance expertise, private sessions with compliance personnel and information

■ Reporting lines and related structures

■ Experience, qualifications and performance of the chief compliance officer and compliance function

■ Compliance function responsibilities, budget and budget allocation (including employees, outside advisors and other resources), staff turnover rate and outsourcing

■ Written corporate policies and procedures regarding ethics and compliance (including legal and regulatory risks), and the process for designing, reviewing and evaluating the effectiveness of policies and procedures

■ Internal controls to reduce the likelihood of improper conduct and compliance violations

■ Ongoing monitoring, control testing and auditing processes to assess the effectiveness of the program and any improper conduct

■ Role of compliance in strategic and operational decisions

■ Key compliance risks, risk assessment processes and risk mitigation

■ Senior management conduct and commitment to compliance, and how the company monitors this

■ Communication efforts by the board, CEO, other senior executives, and middle management regarding expectations and tone

■ Education and training regarding compliance generally and the company’s program, policies and procedures at all levels

■ Understanding of corporate commitment to compliance at all levels

■ Awareness and use of mechanisms to seek guidance and/or to report possible compliance
violations, and fear of retaliation

■ Specific problems that have arisen, why they arose and how they were identified and resolved

■ Investigation protocols and experiences

■ Performance incentives, accountability, disciplinary measures and enforcement

■ Remediation and efforts to apply lessons learned

The DOJ’s recent guidance should help boards determine the assessment process that is appropriate for the company, evaluate whether the company’s program continues to be effective and t for purpose, and consider appropriate modi cations to the program.

Sidley Perspectives | JUNE 2017 • 4

*Holly J. Gregory is a partner in Sidley’s New York of ce and a co-leader of the rm’s global Corporate Governance and Executive Compensation practice. Rebecca Grapsas is counsel in Sidley’s Corporate Governance and Executive Compensation practice who works from both the rm’s New York and Sydney of ces. The views expressed in this article are those of the authors and do not necessarily re ect the views of the rm.

NB: Privacy, Data and Cookies Policy, Protects Facebook from Litigation

JUNE 7, 2017 CLIENT ALERT

Privacy Policy Rescues Facebook from Costly Litigation

From Michael Best & Friedrich.

We have all gone to a website and, in accessing the website’s services, have agreed to terms and conditions that include a litany of policies, including privacy policies governing how the company maintaining the website will use our information obtained while accessing the website. One such specific website that most, if not all, of us have used is Facebook. While we may not pay very close attention to privacy policies such as data and cookie policies, those policies explain that Facebook uses cookies or browser fingerprinting to identify users and track what third-party websites users browse. Such privacy policies serve an important function for any company, including Facebook, to help protect against potential liability for use of a consumer’s information. Indeed, Facebook’s privacy policy just carried the day in getting a case dismissed against it in which the Plaintiffs alleged a litany of causes of action against Facebook, including violation of the Computer Fraud and Abuse Act, California Invasion of Privacy Act, Health Insurance Portability and Accountability Act, and other common law claims.

In Smith v. Facebook, Inc., Case no. 16-cv-1282, the Northern District of California dismissed the claims against Facebook, with prejudice, based upon Facebook’s user agreement. There, the Plaintiffs argued that Facebook violated numerous federal and state statutes, as well as common law, by tracking and collecting its users’ web browsing activity, including sensitive information from various healthcare websites. In dismissing the case, the Court found that Plaintiffs had consented to Facebook’s tracking and marketing activity when they agreed to Facebook’s “data policy” and “cookie policy” when opening a Facebook account. The Court further found that while the applicable policy provisions were broad, they were not vague and provided adequate notice of the tracking activity in which Facebook engaged. For example, a portion of Facebook’s “cookie policy” explained that “[t]hings like Cookies and similar technologies (such as information about your device or a pixel on a website) are used to understand and deliver ads, make them more relevant to you, and analyze products and services and the use of those products and services . . . we use cookies so we, or our affiliates and partners, can serve you ads that may be interesting to you on Facebook Services or other websites and mobile applications.” Simply put, Facebook’s privacy policy, which Plaintiffs had agreed to when they signed up for Facebook, was adequately clear to permit Facebook to track and collect Plaintiffs’ web browsing activity, including browsing of healthcare related information. In so finding, the Court rejected Plaintiff’s arguments that the policies were buried and overbroad.

Facebook’s recent victory is a good reminder of the importance of having a thorough and clear privacy policy. Any company that collects or uses consumers’ information should aim to have a transparent and broad privacy policy to help guard against liability.

Albert Bianchi, Jr.
abianchi@michaelbest.com
T.608.283.4425

Michelle L. Dama
mdama@michaelbest.com

Heads Up: Board of Directors, Resignation from the Board, Duty of Loyalty.

When a venture capital fund invests in an emerging growth company, it typically seeks to protect its investment by obtaining the right to designate a member of the Board of Directors. While many of these individual designees are experts in their field and have vast networks of valuable relationships at their disposal, a newly designated director may be unfamiliar with the duties imposed on him should he want to resign. Paul Hastings Client Alert

March 2017 Follow @Paul_Hastings

Resigning From a Board of Directors:Considerations for VC Fund Designees
By Samuel A. Waxman, Jordan L. Goldman & Brooke Schachner

When a venture capital fund invests in an emerging growth company, it typically seeks to protect its investment by obtaining the right to designate a member of the Board of Directors. While many of these individual designees are experts in their field and have vast networks of valuable relationships at their disposal, a newly designated director may be unfamiliar with the duties imposed on him should he want to resign.

Delaware law generally gives the Board of Directors broad authority to manage the business affairs of a corporation. Although this level of discretion is generally extended to the ability to resign, there are various factors that should be considered when weighing the value of keeping a seat against the potential turmoil and liability associated with resignation. Designated directors often reflexively consider resignation when the company has run out of money or is heading into the so-called “zone of insolvency” out of fear of personal liability. Resigning at this point, however, may actually give rise to the very liability the director was seeking to avoid. As a result, it is important for a director to know when he can resign versus when he should resign.

I. The Benefits of Sitting on a Board: A Seat at the Table
The best way for a venture capital fund to remain informed and maintain influence on a company’s decision-making is to hold a seat on the Board. Directors have the power to vote on matters mandated by Delaware law, the certificate of incorporation, or the investment documents that affect material aspects of the business and its stakeholders. For example, Board approval may be necessary for: amendments to the certificate of incorporation and bylaws; equity grants or transfers (whether stock, options, or warrants); distributions to stockholders; borrowing or lending money; adopting an annual budget; hiring or terminating members of senior management (or amending their terms of employment); adopting employee benefit plans; a sale of material assets of the company; adissolution of the company; and/or entering into agreements and transactions of material importance to the company (intellectual property licenses, mergers, or IPOs).

This remains true even if the investment has gone sour. Directors will continue to have say over bridge financings, the direction of DIP loan packages, and other key decisions that need to be made by a company in distress.

II. Should I Stay or Should I Go?
Under Delaware law, a director generally may resign at any time, unless the certificate of incorporation or bylaws require otherwise. Notably, however, a director may not resign when doing so would constitute a breach of the duty of loyalty.

A. Duty of Loyalty
Directors have a duty to act in the best interests of the shareholders—personal benefit is secondary, even if management is making questionable choices. For example, simply resigning upon discovery of flagrant crimes committed by corporate insiders, without attempting to rectify the issue, may constitute a breach of the duty of loyalty. In In re Puda Coal Shareholders’ Litigation, a CEO was accused of theft through unauthorized transfers which went unnoticed for 18 months. A third party brought the suspected criminality to the attention of the independent directors, but the directors were “stonewalled” by management when they attempted to bring suit. So, the independent directors resigned from the Board. The Delaware court was critical of the directors’ decision to resign rather than cause the company to join a related derivative suit, stating that simply resigning at that point (while the company was in hot water) might be a breach of the duty of loyalty.

Similarly, in Rich v. Chong, another Delaware case, the court determined that ignoring numerous red flags and resigning from the Board may have constituted an abdication of the directors’ duties. In this case, the company completed its public offering in 2009. In 2010, it revealed discrepancies in its financial statements, and in 2011, auditors discovered a $130 million cash transfer to third parties in China. A 2010 stockholder suit urged the company’s audit committee to investigate, but the investigation was abandoned in 2012 due to management’s failure to pay the fees incurred by the audit company’s advisors. The company also failed to hold an annual stockholder meeting for several years despite a 2012 court order to do so. The independent directors subsequently resigned. Chiding the directors, the court stated that “the conscious failure to act, in the face of a known duty, is a breach of the duty of loyalty.”

Directors of companies with foreign operations, moreover, are subject to a heightened fiduciary duty. Delaware Supreme Court Chief Justice Strine’s view on local companies with foreign operations is that a director’s required engagement is even more strenuous (e.g., traveling to that foreign country, having language skills, and knowing the culture).

B. Reasons for Resignation
A director may want to resign from his position on the Board for several reasons. If the company breaks the law or materially breaches its bylaws or shareholder agreements, without immediate rectification, a director may consider resignation. In addition, a director may deem it necessary to resign over disagreements among the Board members. Deadlocks and discord can severely impede progress—a particular concern for growth companies. While discussion and debate is healthy for an effective Board, intractable differences of opinion about the company’s future can stall innovation and stifle success. Similarly, a fundamental opposition to some of the company’s major practices could be reason enough to step away.

Designees are often selected for board seats because of their expertise in a particular field and their vast network of connections. However, a conflict of interest may arise as a result. If conflicts of interest persist and become irreconcilable, a director’s exit might be best for all parties involved. Still, a director’s fiduciary duties to the corporation and its shareholders must be at the forefront of one’s concerns, and if an exit may constitute a breach of the duty of loyalty, directors must think twice
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about resignation. In addition, while the director himself may not have a personal conflict, a designated director might wish to resign if the fund they represent is going to engage in certain debt financing transactions with the company.

Additionally, a director may want to resign if he is unable to obtain adequate protection against personal liability. A director should ensure that the company has a sufficient director and officer (“D&O”) insurance policy and an indemnification agreement in place that protects individual directors. It is important to make sure D&O policies have a proper tail so that directors are still covered even after they leave the Board. A director is often best served staying on the Board as long as possible to make sure that the D&O insurance is kept in place at the expected levels and/or to best negotiate a tail on his exit. Without appropriate D&O insurance, directors may face liability for certain claims against the corporation. Notably, a recently enacted California law includes directors in the group of individuals that may be held personally liable for unpaid final wages. While a director may be covered by insurance or indemnification in this instance, it is important to be aware of state laws that may subject corporate agents to additional liability.
Finally, evidence that management is not acting in the best interests of the shareholders may be cause for a director’s resignation. But again, a director has to be sure that his exit does not unduly harm the company or breach a fiduciary duty owed to the shareholders.

III. Practice Tips for the Director Pondering Resignation
When considering resignation, a director must act in the best interests of the company. Current or potential directors should research whether there are any unusual restrictions on resignation in the certificate of incorporation or bylaws or unusual internal procedures and policies.

Moreover, a director should take specific steps upon the discovery of illegality or malfeasance, namely:
1. A director’s first duty is to take reasonable steps to stop any ongoing legal or ethical violations.
2. If met with stonewalling, the director should seek independent legal counsel.
3. A director who decides to resign may want to submit a written statement to the chairman for circulation to the Board and possibly to the shareholders.
Following these general steps will ensure that a director can leave a Board while guarding against potential liability. The decision to resign from a Board must not be made flippantly. Facts and circumstances will rule the day; regardless, a director must always mind his fiduciary duties to the company and its shareholders.
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Boards and Business Executives Beware- Possible Liability For Data Breach

Publication By Michael Best
Albert Bianchi, Jr.Michelle L. Dama, Adrienne S. Ehrhardt
MARCH 3, 2017CLIENT ALERT

Executives and Board Members Could Face Liability for Data Breaches

Executives and Board Members Could Face Liability for Data Breaches
By now, most everyone is aware that Yahoo was hacked in both 2013 and 2014 and had names, passwords, and other account data of between 500 million and one billion of its users stolen. Following the breach, various class action lawsuits brought against Yahoo by consumers and small business users of Yahoo ensued. The stolen data and lawsuits also caused Verizon to reduce its offer to purchase Yahoo by $350 million. Unfortunately for Yahoo, its inability to protect private account data has led to additional negative consequences.
In late February 2017, a group of Yahoo shareholders, guided by the Oklahoma Firefighters Pension and Retirement System, sued Yahoo, as well as some of its executives and board members, including the chairman of its Board of Directors, co-founder, and current CEO, for breach of their fiduciary duty to the shareholders stemming from the stolen account data. Although the complaint is sealed (and thus unavailable to the public), the lawsuit, which appears to be the first of its kind, seems to assert that Yahoo and its executives breached their fiduciary duty to shareholders by failing to disclosure the data security breaches to Yahoo account holders.
This lawsuit will be one to keep an eye on to see whether a failure to properly handle a data breach, and possibly even the data breach itself, can be considered a breach of a fiduciary duty to shareholders. Although this case appears to be the first of its kind, if it continues moving forward, it will undoubtedly spur like cases for other similarly situated entities that have suffered a security breach.
Other businesses that have been hacked and had personal account data stolen may be next in line for similar shareholder lawsuits. As such, the shareholder suit against Yahoo and its executives is yet another warning of how important it is for business to approach the need to properly protect personal data seriously. Whether its employee or customer information, businesses need to be on their guard and prepared to prevent and handle data breaches.

Boards Of Directors in 2017: 5 Trends To Be Aware Of.

Previously posted in Private Company Director Magazine

The Responsibilities Of Boards Continue To Increase, Demanding Increased Director Awareness and Understanding Of Developments Likely To Impact That Business.

2017 Board of Directors Predictions: 5 Trends to Watch
By Brian Stafford

“For board members and directors tasked with guiding their companies through these changes and the complexities that could arise in the aftermath of 2016, change is needed in the boardroom as well. From expanding skillsets to greater accountability for brand reputation and issues management, here are five of the top trends that will make the biggest impact on boards in 2017”.

2016 was a year marked by significant changes—stunning political upheavals via Brexit and our own controversial new President-elect; a growing number of big-ticket, multi billion dollar M&A deals amid massive enterprise court battles, particularly in the technology sector; evolving regulations and proposed governance standards; as well as persistent and increasingly destructive cyber security attacks, threatening everything from the outcome of the U.S. election to the sale of Yahoo to Verizon for $4.8 billion.

For board members and directors tasked with guiding their companies through these changes and the complexities that could arise in the aftermath of 2016, change is needed in the boardroom as well. From expanding skillsets to greater accountability for brand reputation and issues management, here are five of the top trends that will make the biggest impact on boards in 2017.

Prediction 1: Individual Accountability Becomes a Focus

Board members will be measured by more than just collective financial performance, but also for their personal effectiveness, diligence, ethical quotient (EQ) and contribution to the corporate brand. Thus, it will be imperative for board members to evaluate the security of their confidential digital communications (both personal and professional), and adopt modern best practices designed to protect the integrity of sensitive information, and ultimately, the brand’s reputation.

Prediction 2: Diverse Board Members Wanted (& Needed)

Boards have often been criticized for lacking the diversity and modern skillsets needed to compete in today’s fast-paced and technology-driven business world. However, in order to both solve complex challenges facing businesses today, as well as capitalize on market opportunity globally, more diverse views, experiences and skill-sets in the boardroom are needed.

This evolution will revolve around three key areas:

1. More women as directors
2. Board members with varied skill sets (such as technology and security)
3. Unwavering commitment to technological adoption in the boardroom, and across the enterprise.

Prediction 3: Greater Accountability Calls for Improved Collaboration

In 2017, board members must also have more transparency, authority and collaboration to advise and make key decisions in tandem with company decision makers.

As the level of accountability grows, there will need to be a redistributed line between the board and executive management. This new redistribution will also guide how the board interacts with activist investors, shareholders and each other.

Prediction 4: Cyber Security Becomes a Board Problem

In 2017, boards will need to strongly consider adding individuals with CIO/CISO experience. Cyber security is perhaps the single biggest risk to enterprises today, with breaches impacting corporations around the world daily, and many are not ready for battle.

To help better prepare, boards will need to make it a priority to enhance public-private partnerships and utilize third party providers to leverage the cumulative cyber-knowledge of its whole network. This will help solve fundamental problems like a lax security culture, knowing where data is located and how regulations will impact the company.

Prediction 5: Political Changes Enter the Boardroom

President-elect Donald Trump promises to bring about a variety of changes to foreign policy, domestic practices and corporate governance. With Trump in office, board members will need to keep an even closer eye on how corporate governance is set to change, including new requirements for board oversight as well as the evolving role of the corporate secretary. In fact, there’s already talk of potential changes to key legislations such as dismantling Dodd-Frank and swift immigration and labor changes.

2017 will undoubtedly be a transformative year for many enterprises and the boards that govern them. While time will tell how each of these trends will impact boards, I am willing to bet that those that continue to evolve and adhere to industry best practices will outperform those that stick with the status quo.
Brian Stafford is Chief Executive Officer of Diligent Corporation. Brian is responsible for all day-to-day operations, with a focus on accelerating global growth and incorporating scale into the business in order to seamlessly manage the growth. Brian previously served as a Partner at McKinsey & Company, where he founded and led their Software-as-a-Service Practice. Prior to his tenure at McKinsey, Brian was the Founder, President and CEO of CarOrder, a division of Trilogy Software based in Austin, Texas. Brian is also an active seed stage investor and start up advisor. His other passion lies in the arts, supporting the NYC community in his role as a BAM board member.

How Some Family Offices Are Changing Their Investment Strategies

Previously posted on LinkedIn.

Food For Thought On Some Family Offices’Changing Strategies for Investment, and For Direct Investment In Particular.

Balancing what can, therefore, be a rather imprecise notion of ESG performance or “impact” and the asset’s financial performance within the decision-making and constitutional framework of a family office may not be without its complications and some will take to this approach more readily than others.

Family Office Insights
Sustainable and Impact Investing: An Increasing Focus for Family Offices
As highlighted in our previous “Family Office Insights” piece, the last few years have witnessed a growing number of family o ces undertaking direct investments and developing their human and technical resources as enablers for such investments. While not without its challenges, such a strategy can deliver economic benefits by way of reduced fund management fees while giving investors a greater level of engagement and in uence within the underlying businesses.
At the same time, we are seeing mounting evidence to suggest that more and more family o ces are turning their focus and capital allocations toward businesses and assets that satisfy certain environmental, social and corporate governance (ESG) criteria and/ or that seek to achieve positive social or environmental “returns” or “impact” alongside nancial performance.
This is, of course, not a trend that is exclusive to family offices and should not come as a surprise. We live in a world of increasing interest in the environmental and social consequences of business and trade, where the behavior of corporations is scrutinized more and more rigorously, and so the impetus for making investments in and supporting organizations that have a positive impact on society will surely continue to strengthen. As social awareness and pressure increases, it seems inevitable that the whole gamut of investors, across the private and public sectors, will look to increase their exposure to, or use of, products or assets that satisfy certain ESG, “green” or “impact” criteria in one way or another.
Nor is this a recent phenomenon; the idea of investing to align with ethical standards or to incentivize or disincentivize certain types of environmental or social behavior is long established.
What has perhaps been a catalyst for the more recent trend, however, is a realization by many investors that companies (and the instruments deriving from them) operating ESG-sensitive business practices are capable of matching, if not outperforming, their peers and comparable investments from a nancial perspective.
Converging Trends
There could be said, to be some degree, of correlation between the growing trend of direct investments by family o ces and the increase in capital being allocated by family offices to businesses or investments that operate with ESG considerations at their core, especially those that can truly be said to be “impact investments.”
The Millennial generation is undoubtedly more influenced by and
in tune with ESG concerns than their forebears, and with a large number of 30-40-year olds now starting to assume greater decision- making responsibility within their own family organizations,
greater proportions of the capital at their disposal is now being aimed in this direction. The emergence of a new cohort of global entrepreneurs with strong social and ecological consciences and loud social media-enabled voices no doubt adds further support to the momentum of a generation who want to put their money to work in a socially productive and bene cial way, while still generating acceptable investment returns.
More particularly, while liquid assets in this space such as ESG- oriented equity funds become increasingly prevalent and investable and will continue to attract a meaningful share of available capital, alternative assets such as direct investments can o er a much more “hands-on” approach to ESG investing, by removing intermediaries and often giving investors a role in the operation or governance of a business, enabling them to make an “impact.” Reputational benefits by association may also accrue to families that are seen to be actively involved with ESG businesses and investments, which can add to the appeal for some family organizations. For the right asset and assuming nancial performance targets are achievable, there can then be a compelling investment rationale at the con uence of these developing trends.
What Are the Challenges?
In the case of direct investments, identifying and gaining access to the right investment opportunities and then executing them will present the sort of challenges with which family offices are increasingly familiar.
As well as the typical hurdles of sourcing deal flow and identifying investment opportunities, there is the more fundamental question
of how to measure performance as far as ESG or “impact” is concerned. This is essentially an emerging asset class that is still in its infancy; there is no such thing as standardized criteria with which to measure “impact” against, and while corporate governance (the “G” of ESG) has received considerable attention and is some way toward more global or regional standardization, the other limbs of this commonly used acronym remain di cult to quantify or verify. In the US and in other jurisdictions, including the UK, the development of the “bene t corporation” model, aimed at addressing ESG concerns and social investing more generally, does, however, show signs of providing one form of veritable framework in which to join a for-profit enterprise with a social investment goal.
While the general trend seems, therefore, to be one of ever-increasing development, transparency and disclosure (other examples of which include the “comply or explain” regimes for public companies, requirements for regulated funds and the proliferation of ESG-oriented indices in the public equity and debt markets), which will help with the evolution of best practice and benchmarks for many investors, an assessment of performance from an ESG or “impact” perspective will often be to a large extent subjective.
Balancing what can, therefore, be a rather imprecise notion of ESG performance or “impact” and the asset’s financial performance within the decision-making and constitutional framework of a family office may not be without its complications and some will take to this approach more readily than others.
How Advisers Can Help
There will be a range of areas in which external advisers can help, depending on the asset in question and what the investment aims and objectives are.
A thorough understanding of the business model and particularly the supply and distribution chains will be critical and, accordingly, a more bespoke and possibly more intrusive approach to due diligence might be necessary. Likewise, a familiarity with the markets the business operates in and the local public policy landscape may be more valuable than it might otherwise be. Negotiating and obtaining appropriate governance and information rights, giving an ability to direct or monitor specific aspects of its investment, can also become a crucial aspect of the deal terms and may go beyond what is typically sought by a minority investor. Where direct investments are made in real estate, analyzing and agreeing to the terms and conditions applicable to tenants and potential service providers can also be a means of shaping the performance and credentials of the asset. In the case of funds and listed entities, where the opportunity for direct “impact” will be more limited, investors may wish to consider how they can influence performance or behavior by way of shareholder activism or softer, more diplomatic means such as raising concerns with directors and fund managers directly. With such a variety of approaches and considerations, there will, therefore, be numerous ways in which advisors should be able to add value to the process throughout the life cycle of the investment.

Contacts
Robert J. Shakespeare
Of Counsel, Singapore
T +65 6922 8674
E robert.shakespeare@squirepb.com
Daniel G. Berick
Partner, Cleveland
T +1 216 479 8374
E daniel.berick@squirepb.com
The contents of this update are not intended to serve as legal advice related to individual situations or as legal opinions concerning such situations nor should they be considered a substitute for taking legal advice.

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