In the past several months, Congress has held extensive hearings and members of Congress have introduced dozens of bills on a wide range of issues emanating from the Enron collapse. One such bill, the Corporate Auditing Accountability, Responsibility and Transparency Act of 2002, has passed the House, while another bill, the Corporate and Criminal Fraud Accountability Act of 2002, has been approved by the Senate Judiciary Committee. The SEC has proposed a number of rulemakings and promises more to come.
Many of the proposals-particularly ones originating in Congress-have the potential to seriously affect director and officer obligations and liabilities. Among the more serious matters under consideration are the following:
- Early reporting of securities trading activities of directors and officers;
- Expanding the authority of the SEC to bar persons from serving as directors or officers of public companies;
- Extending the statute of limitations or securities fraud actions;
- Repealing or amending many of the procedural protections of the Securities Litigation Reform Act of 1995 (Reform Act);
- Expanding joint and several liability and reimposing aider and abettor liability in securities fraud actions;
- Eliminating the securities fraud exclusion from civil RICO, opening the potential for treble damages claims for securities fraud;
- Requiring disgorgement of bonuses and other incentive-based forms of compensation in cases of accounting restatements resulting from misconduct;
- Making unlawful "improper influence" over an audit;
- Expanding protections for corporate "whistle-blowers;" and
- Creating new securities fraud crimes and enhancing the minimum criminal penalties for securities fraud.
With all of the proposals to expand civil and criminal liability and penalties, it is important to keep in mind that corporations can provide only limited protections to their directors and officers. Corporations generally can indemnify directors and officers against certain liabilities, provided they meet a specified standard of behavior. Corporations also generally can limit the liability of directors to the corporation and its stockholders for breach of fiduciary duty. These provisions cannot, however, protect directors and officers against claims asserted under the federal securities laws or from personal liability under federal or state criminal laws. Most director and officer liability insurance policies exclude coverage for losses arising from fines or penalties imposed in a criminal proceeding or where the director or officer realizes personal profit or gains an illegal advantage or the loss was caused by the fraudulent, dishonest, or criminal acts of the director or officer.
Not all of these proposals will be adopted, but changes to the director and officer liability landscape and to practices of Boards and management teams are likely to be substantial. At a minimum, the new proposals could result in corporate officers and directors needing to document greater due diligence efforts as a means of protecting themselves from potentially substantial litigation and liability risk.