Many companies provide advancement, indemnification and insurance benefits and protection for their officers and directors. However, it is not always clear who is an “officer” for purposes of claiming the benefits and protection. The long-running and high-profile saga of Sergey Aleynikov, the former Goldman Sachs computer programmer and company Vice President accused of stealing proprietary electronic computer code used in the company’s high frequency trading platform, presents a vivid example of the problems that can arise when the meaning of the term officer is unclear.
In a September 3, 2014 opinion (here), the Third Circuit found that the term “officer” in Goldman’s bylaws to be ambiguous and therefore vacated the district court’s ruling that Aleynikov was entitled to advancement from Goldman of his criminal defense expenses. As discussed below, the Third Circuit’s opinion underscores the problems involved when indemnification provisions do not clearly specify who is an officer entitled to the provisions’ benefits. The opinion also presents a number of lessons for those involved in drafting indemnification provisions.
Goldman, Sachs & Co is a broker-dealer limited liability partnership organized under New York law. It is a non-corporate subsidiary of GS Group, a Delaware Corporation. Aleynikov was employed by GSCo from May 2007 through June 2009 as part of a team of computer programmers responsible for developing source code for GSCo’s high frequency trading system. During his GSCo employment, Aleynikov carried the title of “vice president.” He did not supervise other employees and he exercised no management or leadership responsibilities.
In April 2009, Aleynikov accepted a job with a start up company in Chicago. Before leaving GSCo, Aleynikov allegedly copied onto his home computer thousands of lines of confidential source code. Aleynikov was later arrested and charged federally with theft of trade secrets in violation of the Electronic Espionage Act. Aleynikov was convicted of the federal charges and sentenced to 97 months in prison. However, the Second Circuit reversed the conviction on the grounds that Aleynikov’s conduct did not fall within the scope of the charged federal offenses. Shortly thereafter, Aleynikov was indicted by a state court grand jury on charges of unlawful use of secret scientific material and unlawful duplication of computer related material. The state court charges remain pending.
Michael Lewis, the author of Moneyball and Liar’s Poker, has a very interesting and detailed account of Aleynikov’s odyssey through the criminal justice system in a September 2013 Vanity Fair article entitled “Did Goldman Sachs Overstep Criminally Charging its Ex-Programmer?” (here). Lewis’s article is worth reading even if you aren’t interested in the other legal issues surrounding Aleynikov’s criminal prosecution.
Aleynikov filed a civil action in the District of New Jersey seeking indemnification for the defense expenses he incurred in the federal criminal action and seeking advancement of his defense expenses in the state criminal action. In seeking indemnification and advancement, Aleynikov sought to rely on Goldman Sachs Group’s bylaws, under a provision applicable to non-corporate subsidiaries like GSCo. The provision specifies that “the term ‘officer’ shall include in addition to any officer of such entity, any person serving in a similar capacity or as the manager of such entity.”
Goldman opposed Aleynikov’s entitlement to either indemnification or advancement, arguing that despite his “vice president’ title, Aleynikov was not an officer of his company, and that in any event, whatever indemnification rights Aleynikov may have for his successful defense of the federal criminal action, his rights are subject to set-off based on the company’s counterclaims against him for breach of contract, misappropriation of trade secrets and conversion. The parties cross-moved for summary judgment.
As discussed here, in an October 2013 opinion, District of New Jersey Judge Kevin McNulty granted summary judgment in Aleynikov’s favor on his claim for advancement but denied his motion for summary judgment on his motion for indemnification. Judge McNulty also denied Goldman’s cross-motion for summary judgment on the indemnification issue. Goldman appealed to the Third Circuit.
The September 3 Opinion
In a September 3, 2014 majority opinion written by Judge Raymond C. Fischer (with Judge Julio Fuentes dissenting), the Third Circuit concluded that the term officer as used in Goldman’s bylaws was ambiguous and accordingly vacated the District Court’s grant of summary judgment on the advancement issue. The appellate court affirmed the district court’s denial of Goldman’s motion for summary judgment on the indemnification issue.
In concluding that the word officer as used in the bylaw was ambiguous, the court said that the bylaws’ definition of the term was “circuitous, repetitive, and mot importantly, fairly or reasonably susceptible to more than one meaning.” Because the court determined that the term was ambiguous, it determined that it could look beyond the bylaws themselves to determine the intended meaning of the term.
The court concluded that two kinds of extrinsic evidence are relevant to the inquiry – “course of dealing” evidence and “trade usage” evidence. With respect to the course of dealing evidence, the court said that Goldman’s procedure for appointing and removing officers, which the district court had discounted because they were not always followed and were not in any event made public, may be of relevance for a jury to decide.
The appellate court also referred to evidence Goldman had introduced on its track record of providing indemnification for other individuals at GSCo. The record showed that over a six year period, Goldman has paid the attorneys’ fees of fifty-one of fifty three who had sought indemnification. More specifically, Goldman had paid the attorneys’ fees of fifteen of seventeen “vice presidents” who has sought indemnification. The district court had discounted this evidence, but the court said it provided some evidence from which a jury could interpret Goldman’s contention that indemnification decisions were discretionary.
Finally the court considered the trade usage evidence Goldman had offered, which was that there has been significant “title inflation” in the financial services industry and that the title “vice president” is not particularly meaningful. The district court had also discounted this evidence, in effect saying that it was Goldman’s problem that it might have been profligate in its bestowal of titles.
The appellate court said that the extrinsic evidence that Goldman offered raised genuine issues of material fact on the question of whether or not Aleynikov was entitled to advancement under the relevant bylaws. In concluding that it was appropriate for the extrinsic evidence to be taken into account, the appellate court also rejected the argument, that the district court had accepted, that in any event as the creator of the bylaw, the bylaw should be interpreted against Goldman under the principles of contra preferentem. The appellate court said that interpreting the bylaws in Aleynikov’s favor against Goldman is “putting the cart before the horse” because, the court found, there was a prior question of whether or not Aleynikov was a beneficiary of the bylaws.
In his dissent, Judge Fuentes said that while he agreed that the term officer as used in the bylaws was ambiguous, he believed that under Delaware law an ambiguous term in a corporate instrument should be construed against the drafter rather than inviting use of extrinsic evidence to decipher the term’s meaning. He would have interpreted the ambiguity of the definition against Goldman, particularly given Delaware’s strong public policy in favor of advancement. On that basis, Fuentes said, he would find that as a Vice President, Aleynikov is an officer and therefore entitled to have his legal fees advanced.
This high profile case has drawn a great deal of attention and scrutiny, in part because of the notoriety of the allegations against Aleynikov, in part because of the snicker-inducing aspect of some of the details of the dispute — such as, for example, Goldman’s argument that, in effect, it doesn’t mean all that much in the financial services industry for someone to have the title of Vice President.
While this case has garnered much attention, the basic question involved is one that arises all too often when lower level personnel are seeking advancement and indemnification. Bylaw provisions are often unclear on the question of who is an officer. At a minimum, this case illustrates the problems that can arise when bylaw provisions do not define precisely who is an officer for purposes of entitlement to advancement or indemnification.
It could be argued that companies have an incentive to keep these questions ambiguous, in order to try to preserve an element of discretion. Certainly, in this case, Goldman wants to be able to argue that it should no indemnification or advancement obligations for someone it contends stole valuable intellectual property. However, there is one very practical reason why anyone involved in drafting corporate bylaws would want to ensure that there are no ambiguities and that the provisions are mandatory and are set up to operate automatically. That is, at the time the provisions are written, no one has any way of knowing whether or not they themselves might be the ones seeking to rely on the provisions.
The dissent referred to the strong Delaware public policy in favor of advancement, which was a very important consideration in the district court’s resolution of the summary judgment motions as well. The appellate court’s majority opinion did not address this public policy issue as such. However, this case demonstrates the reason why the public policy in favor of advancement can be so important. Aleynikov is facing ongoing criminal charges and has no choice but to try to defend himself as best he can. With the denial of summary judgment on the advancement issue, he must now try to convince a jury he is entitled to advancement – but in the meantime the state law criminal case is going forward. A jury verdict on the advancement issue may come too late for him to be able to defend himself. Aleynikov’s circumstances may suggest why the strong public policy in favor of advancement is important.
Again those drafting indemnification provisions have an interest in seeing that the measures are enforced with a bias in favor of advancement and indemnification, as at the time the provisions are drafted, no one has any way of knowing who will want to or have to try to take advantage of the provisions. Would-be indemnitees will not want to find their claim of entitlement to these benefits depend on whether or not a court recognizes and enforces a public policy in favor of advancement, so what those drafting bylaw provisions will want to do is to incorporate into the bylaws provisions that affirmatively specify that there will be a presumption in favor of advancement and providing a mechanism for interim payments if there is a dispute over the entitlement to advancement.
Another issue that those responsible for drafting indemnification provisions may want to keep in mind is that when the companies involved have, like Goldman Sachs here, complex corporate structures, it may make sense for the separate operating units to have separate indemnification provisions. As pointed out in the Kirkpatrick & Townsend law firm’s September 9, 2014 memo about the Third Circuit’s decision (here), if the Goldman subsidiary involved in this case had had its own separate indemnification provisions, then “the ambiguity in this case about who is entitled to the benefit might have been avoided.” Similarly, and as the law firm memo also points out, if there were clear procedures for appointing officers and the procedures were widely disseminated and followed, it would be easier to determine who was intended to be part of that group.
These kinds of questions are not limited just to the indemnification and advancement context. Many of these issues may also arise in the context of D&O insurance as well. The question of whether not a particular individual is or is not an insured person under the policy is a frequently recurring issue, particularly where lower level employees are involved. This question may be less of an issue in a private company D&O Insurance policy, where the policies broad standard definition of insured persons often includes employees.
Under a public company D&O policy, employees may also be insured persons for purposes of Securities Claims. But where the claim involved is not a Securities Claim, difficult questions can arise. Under a public company D&O insurance policy outside of the Securities Claim context, employees typically are not included in the definition of insured persons. Rather, the policy will typically define an insured person as a “duly elected or appointed director or officer” or similar words. The problem in situations like Aleynikov’s is that it unclear whether or not, as a Vice President, he would come within this definition. The question that may well arise is whether or not he was duly elected or appointed and therefore would come within this definition. One way some companies will choose to address this policy is to request that the policy be specially endorsed to specify that persons holding specific titles or offices are insured persons within the meaning of the policy.
Of course, board member and senior executives may not want their company’s D&O insurance to be eroded by claims raised against lower level employees. This concern would be particularly magnified in a situation like this one where the claim against the lower level employee is that he misappropriated intellectual property belonging to the company. All of which underscores that there are certain fundamental tensions and even conflicts of interest involved in (and perhaps inherent in) both indemnification and insurance arrangements. Some of those with potential interests in indemnification and insurance would like to see those benefits made broadly available. Others – and often the company itself—have interests in seeing the benefits being made available only narrowly.
These more theoretical questions – that is, how broadly should the benefits be made available – often are not considered at the outset. Often the arrangements are made with an unconscious (or unexamined) bias, such as for example that it is always better to have indemnification and insurance broadly available. It is perhaps a inquiry for another day, but these questions often are not fully examined.