I am pleased to present below a guest post by Kara Altenbaumer-Price, Esq., the Director of Complex Claims and Consulting for USI and part of its Management & Professional Services Group in Dallas. I would like to thank Kara for her willingness to publish her article on this site. I am interested in publishing guest posts from responsible commentators on topics of interest to readers of this blog. Please contact me directly if you are interested in submitting a guest post for consideration.
Here is Kara’s guest post:
As insureds try to navigate through the new language and products being offered by D&O carriers to address increasing costs and coverage issues associated with government investigations, insureds should consider recent remarks by the SEC’s Director of Enforcement pushing for separate counsel in SEC matters. The SEC’s initiative to encourage cooperation with the agency is likely force more corporate officials to seek separate representation, which in turn will only increase the extent of coverage sought under ever-broadening D&O insurance policies.
In 2010, the SEC implemented a number of changes in its Enforcement Manual, a internal SEC document that guides the SEC’s enforcement staff in how—and in some cases whether—investigations proceed forward from informal inquiry to formal investigation to Wells Notice stage. Included in the 2010 revisions to the manual was a program called “Fostering Cooperation” designed to spur confessions by providing leniency—or in some cases, immunity—to individuals who provide valuable evidence to the SEC.
While voluntary cooperation with the SEC enforcement’s division has long yielded benefits for companies, individuals had not necessarily seen the same level of benefit because the SEC had never set out guidelines for granting so-called “cooperation credit” to individuals. On the other hand, the “Fostering Cooperation” initiatives appear to also mean harsher outcomes for those who are offered a chance to cooperate but do not accept. The new enforcement policy, released in January 2010, also gives the SEC access to enforcement tools the DOJ has long used—Cooperation Agreements, Non-Prosecution Agreements, and Non-Prosecution Agreements. Each of these gives incentives for individuals and companies to cooperate with the SEC to lessen their own punishment.
It is likely that more individuals will “confess” to the SEC in order to obtain the benefits of these initiatives. The inevitable D&O insurance challenge is clear: more defense costs. Cooperation by one individual implies that other individuals will be negatively impacted by that individual’s testimony. As more individuals cooperate and as others become the “target” of that cooperation, the need for separate counsel rises, causing a rise in defense costs.
Although the Enforcement Manual is silent about whether the use of joint defense counsel will be considered in evaluating whether an individual has cooperated, the Manual itself acknowledges that multiple representations are common and that “representing more than one party … does not necessarily present a conflict of interest.” Yet, SEC Director of Enforcement Robert Khuzami recently warned against the common practice of defense counsel representing multiple defendants in one SEC matter. He said in a June speech, “We are taking a closer look at such multiple, seemingly adverse representations. You will likely see an increase in concerns expressed by SEC staff in those situations.” While this common practice has always been a concern from a traditional conflicts perspective, Khuzami emphasized the cooperation initiatives only heighten the issue. As he warned in his speech, “this increases the likelihood that one counsel cannot serve the interests of multiple clients, given the real benefits that could result from cooperation, such as one client testifying against another client represented by the same counsel.”
There may be a number of scenarios in which multiple representations are not objectionable to the SEC or insureds, such as, in the SEC’s words, “when one lawyer or one firm represents employees who are purely witnesses with no conflicting interests or material risk or legal exposure.” However, there are many other scenarios in which defense counsel represent multiple clients whose interests may ultimately diverge. For example, Khuzami noted a scenario in which one lawyer represented both an employee and a supervisor in a failure to supervise case.
Indeed, not only is there the possibility that one individual may want to testify against another—or that the company may want to offer up an individual in order to gain cooperation credit for itself—there may be a conflict even between two individuals whose interests may otherwise be aligned because the cooperation incentives create a “race to the Commission.” The SEC has stated that the benefits of cooperation will be reserved for those whose assistance is timely. As Khuzami said in a speech when the initiatives were announced, “Latecomers rarely will qualify for cooperation credit, so there is every reason to step forward – before someone else does.” It is not hard to see the conflict created if a single lawyer or firm finds themselves in the position of choosing which client to help to the front of the cooperation line. This could be true even for insured executives whose culpability level may be low but who may want to avoid the dreaded career-ending director and officer bar.
Interestingly, SEC staff have indicated that they will raise the conflict issue in scenarios in which they recognize that there are individuals who may benefit from a cooperation agreement. For example, the SEC raised just such an issue in an administrative proceeding against Morgan Keegan & Compay and Morgan Asset Management and two employees when it moved to disqualify counsel. The SEC had argued unsuccessfully that the defendants had “potential defendants involving the conflict of [each] other” but that their shared counsel prevented “any such blame-shifting.”
The big insurance question is whether D&O carriers will agree to fund the additional counsel or whether insured companies will get caught in the middle of a push for separate counsel by the SEC (and executives) and the carriers’ push for shared counsel. In the securities context, insureds almost always choose white shoe law firms with corresponding top-of-the-market fees. Sharing defense counsel has long been a method of controlling litigation costs for both companies and carriers. Even with a push for some time by counsel for each executive potentially implicated in an investigation scenario to retain independent counsel, carriers often push back for as few counsel as possible, including offering the incentive of covering the insured entity if the entity shares counsel with individual defendants.
In considering the likely increase in defense costs as separate representations becomes even more likely in SEC matters, insureds would be wise to consider the issue when examining the number of new D&O products on the market addressing insurance coverage for SEC investigations. Companies may also want to consider increased limits as each separate counsel can significantly ratchet up the cost of defense, eating away at limits available for settlement of SEC matters or follow-on civil litigation.