The Same Old Song: Securities Enforcement Cases Against Executives

Following the financial crisis of 2008, the federal government faced harsh criticism for not bringing enough cases against individuals. Since then, government lawyers have consistently crooned the same tune. It doesn’t change much from year to year: A Department of Justice (DOJ) or Securities and Exchange Commission (SEC) leader says individual accountability is extremely important, makes some policy tweaks, and confirms the government will continue to focus on holding bad guys and gals accountable.

This is all fine and good. At a high enough level of abstraction, everyone wants truly bad actors to face the music. As we say to our kids, “Your actions have consequences.” But how do we decide who deserves career-crippling public sanctions or even a one-way ticket to the clink? And how do we decide that, even though mistakes were made, no one person should take the fall?

In this post, I’ll give you a few tips on some of the things that make government attorneys want to bring securities enforcement actions against individuals. (As an aside, and on an encouraging note, outside directors are much, much less likely to be charged than executives.) I’ll also talk about the role of D&O insurance for those who find themselves in the crosshairs of one of these agencies.

A Familiar Tune: Government Rhetoric on Individual Accountability

At least every few years (and certainly after a change in administration), DOJ and SEC officials make speeches and/or write memos about individual accountability. These are well-intended exercises designed to establish and refresh agency policy and provide guidance to industry and defense lawyers. For defense practitioners, these speeches contain nuggets that can be used affirmatively when representing a client. For example, a lawyer may read a speech and then say to the government, hammering the table for effect: “You said that [Factor X] cuts against bringing charges against an individual. Well, if you open an encyclopedia to the [Factor X] page, you’ll find a picture of my client!”

The rest of us should pay more attention to tonal shifts over time. Let’s look at the tune the government has been singing recently.

The Yates Memo (2015)

In the Yates Memo, under the Obama Administration, former Deputy Attorney General Sally Yates provided what looked to many at the time like a roadmap to more aggressive criminal enforcement activities against individual executives. Yates exhorted DOJ lawyers to assess individual accountability rigorously from the start of every investigation and throughout each case. She also directed that companies would not receive cooperation credit unless they “completely disclose all relevant facts about individual misconduct.”

Rosenstein Remarks and “Focus on Individual Accountability” (2018)

Next up at the DOJ, under the Trump Administration, Deputy Attorney General Rod Rosenstein partially changed course, announcing the DOJ would continue to focus on individuals but revising the Yates Memo’s hard-nosed language and signaling a softer touch on forcing corporations to give up every single fact about all potential wrongdoers.

In SEC world, new Enforcement Director Stephanie Avakian highlighted several key principles for the Division of Enforcement, including a “focus on individual accountability.” Two years later, upon the departure of her Co-Director Steve Peikin, the SEC reported: “A central pillar of Mr. Peikin and Ms. Avakian’s tenure has been holding individuals accountable for wrongdoing.” 

Monaco Memo and “Gatekeepers” (2021)

In 2021, under the Biden Administration, Deputy Attorney General Lisa Monaco issued a memo punchily titled: “Corporate Crime Advisory Group and Initial Revisions to Corporate Criminal Enforcement Policies.” In the Monaco Memo, the DOJ revived the Yates Memo’s approach of demanding that corporations turn over “all nonprivileged information relevant to all individuals involved in the misconduct...regardless of their position, status, or seniority.” The DOJ also cautioned against corporate line-drawing (“companies cannot limit disclosure to those individuals believed to be only substantially involved in the criminal conduct.”)

In a speech, new SEC Enforcement Director Gurbir Grewal chose to emphasize that “gatekeepers” such as attorneys and auditors would be “a significant focus” because “they serve as the first lines of defense against misconduct” and “when they don’t, investors, market integrity, and public trust all suffer.”

What are the lessons from the last decade of government messaging on individual accountability? There is plenty of content for defense lawyers to get excited about, but I don’t think the needle has moved enormously.

The available data tend to confirm this theory. In recent years, the SEC has made a point of sharing the percentage of its cases that involved individual charges. Here’s the breakdown:

I’m no statistician, but I don’t see any meaningful trends here. So where does this leave us? While Republican administrations have had a lighter touch and Democratic administrations a heavier hand, for the most part, these have been differences in degree, not in kind. DOJ and SEC lawyers probably feel more empowered to chase after executives today than they did five years ago, but they are still assessing cases through the same general lens. The interesting action is in the case-by-case minutiae, as line government lawyers, supervisors, and leadership make thousands of micro-decisions every year.

Securities Cases Against Individuals: Plus Factors

What differentiates cases where the government decides only to sue a company or to forgo charges entirely and cases where the government rains down hellfire on individual executives? There are many different flavors here. I’m going to exclude cases involving screaming red hot fraud and/or blatant theft from investors. We all know why the government sues those folks. Also, thieves and fraudsters aren’t our target audience here at the D&O Notebook.

Instead, let’s focus on potential disclosure cases against company executives who are running legitimate businesses, getting compensated primarily in equity, and saying or doing things that the government may consider misleading. These are the tough ones—for both the government and individuals. In these cases, the government will be looking for plus factors when deciding whether or not to bring charges. Here are three things to think about.

1. Motive & Soundbites

Not every accounting error or financial restatement results in charges from the government. When charges do result, sometimes they are civil-only charges by the SEC, without a criminal component. In other cases, the SEC refers the conduct to the DOJ and folks go to jail.

The biggest no-no here? Don’t falsify accounting records or documents. That’s a surefire way to get charged by the SEC and to get a very hard look from the DOJ.

In cases involving bad interpretations or inaccurate application of accounting judgment, there is more wiggle room for defendants. In these types of cases, the government will look hard to see whether a CEO or CFO pressured the accounting team to do something that they knew was wrong—extra negative points if the CEO or CFO was getting direct incentive-based compensation as a function of the specific metrics that were inflated. If one those facts is present, you might see SEC charges against executives, but criminal charges are less likely.  Again, if something went stupidly wrong but the SEC doesn’t have good evidence, they may forgo individual charges and just bring charges against the company itself. Before doing so, though, they will kick the tires hard on individual accountability. These cases will live (or die) on the content of your emails and what your team says during on-the-record testimony.

2. There Is Such a Thing as Bad Publicity

There is a strong correlation between media scrutiny and government enforcement risk. Pretend you run an unsexy widget-making business. You tell the street that you will be releasing a new widget imminently. Then things go sideways, the widget is never released, and your company's stock price declines by 35%. While the plaintiffs’ bar may be very interested, the media doesn’t bat an eyelash. Will you be investigated and sued by the SEC? It’s possible, but if there’s no article in The Wall Street Journal, it’s equally possible that the government may never focus on your issues.

Now assume that you run a super-sexy tech company disrupting the industry with WaaS (widgets-as-a-service). When your company's problems emerge, a story appears on the front page of the Journal, and The New York Times does a deep dive on your corporate culture three weeks later. This virtually ensures the government will come sniffing around. In high-visibility cases, the government may be especially focused on showing that they are not being soft on senior executives (if they have the evidence to back it up).

A lot of this is out of your control. Typically, enterprise-facing companies simply don’t have the same media allure as consumer-facing companies. But if as a consumer-facing company you can achieve your public relations and marketing goals without also becoming an object of media obsession, when challenges emerge, you may be happy that you are not front-page material.

3. Friendly-ish Witnesses

When preparing to sue a well-heeled executive, government attorneys don’t want to rely on documents alone. It’s critical to have a witness (ideally, witnesses) who will say things that are somewhat helpful to the government’s case. Emails and Slacks are susceptible to varying interpretations; hearing what happened from a person who was in the room is much more powerful.

Finding cooperating witnesses is much easier for the DOJ than the SEC. When the criminal authorities wave around the prospect of prison time, people tend to find their voices.

The SEC doesn’t have the threat of prison time in its toolbox. As a result, in close cases where the SEC can’t break through the company line, it’s harder to charge individuals. Thus, when dealing with tricky issues involving significant judgment and risk, speak and write with careful attention to avoid unnecessarily sloppy language that will look especially incriminating when blown up to poster size. And make sure your lawyers are involved when you draft tricky communications on difficult topics.

The Role of D&O Insurance and Indemnification

If you are a public company director or officer, D&O insurance will typically respond if you receive a subpoena or become the direct target of a government investigation in connection with your role. You should typically also expect to be indemnified by your company, and the insurance will pay the company back for your defense costs (once the retention is exceeded). Also, if the government sues you and you decide to fight the charges in litigation, you may have coverage (and you also may be indemnified by the company).

But litigating against the government is dangerous for many reasons. One reason is if a judge or jury decides you are liable, that finding can be used by shareholder plaintiffs bringing securities class action litigation. By contrast, if you settle with the SEC, you can typically do so on a no-admit, no-deny basis, which does not have the same  effect in private litigation.

Also, if you lose in an adjudicated proceeding, D&O insurance becomes problematic. D&O insurance has an exclusion for willful wrongful acts, and carriers will also want the defense fees they advanced paid back to them.

Turning to indemnification, the SEC takes the position that it is against public policy for companies to indemnify directors and officers for violations of the Securities Act of 1933. Section 17(a) of the Securities Act is one of the SEC’s biggest weapons against individuals because it allows the agency to allege fraud without any evidence of bad intent. Section 10(b), the intentional fraud provision, arises under a different statute (the Securities Exchange Act of 1934). Delaware law doesn’t specifically preclude companies from indemnifying directors and officers for conduct up to and including criminal guilty pleas, but it does preclude indemnification of bad faith conduct.

When you settle with the government, things can also be tricky. D&O policies will respond on behalf of individuals to pay for their defense costs. However, government penalties are routinely excluded from insurance coverage. (Recently, a state court held that disgorgement, another form of financial sanctions imposed by the SEC, was covered by a D&O policy, but I wouldn’t bank on this going forward.) In addition, when you settle with the government, they may make you swear you are paying directly and are not being indemnified or reimbursed by insurance.

The best course of action? Pay careful attention to your indemnification agreement and be mindful of the steps you can take to stay out of the government’s crosshairs altogether so you don’t find yourself singing the blues.