5 Takeaways From the Carlock Copeland 2017 Accounting Risk Program in Nashville, TN

1. Cyber Insurance is cheap and important to protect against risks not covered by E&O. Work with a knowledgeable broker and insurer and buy the coverage because the risk is real and growing.

2. Make sure your engagement letter includes:
• a specific description of the work you will do;
• limitation of damages provision where not precluded by standards;
• indemnification where not prohibited by standards;
• disclaimers where appropriate ( i.e. AUP’s);
• jurisdiction, venue and choice of law provisions; and
• a provision for the client to pay for time and expense you incur for subpoena compliance.

Watch out for client changes including cyber representations and indemnifications of any kind.

3. Evaluate the risk to your firm before responding to subpoenas or document requests.  Consultation with your insurer or outside counsel may be time well spent.  The risk runs from minimal to existential and different risks require different responses.

4. You save money by not engaging with bad clients.  Red flags include:

• financially stressed or unprofitable  clients;
• clients whose work you are not really equipped to handle;
• clients whose interests conflict with other clients; and
• clients who lack management integrity.

These all should be evaluated for disengagement. Consider firing  your bottom 5 or 10% and investing those resources into developing better opportunities.

5. All of us have clients who present some special risk.  Do what you can to mitigate that risk with:
• thorough client acceptance procedures;
• engagement letters;
• robust conflict analysis; and
• continuous reevaluation.

Employ detailed financial management including precise billing entries, timely billing and early AR follow-up in order to spot problems quickly.

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SAS No. 133: Exempt Securities and a New Audit Standard!!

As public offerings have gotten more complex and expensive, capital has flowed to non-public securities.  Consequently, the exempt securities market has expanded and increased in complexity and risk.  Issued on July 27, 2017, SAS 133 is intended to provide guidance to bring auditing consistency across offerings and increase public confidence in the presentation of financial information.

Beginning with offerings made in June 2018, this new standard will apply when audited financials are used in connection with exempt securities offerings.  Common exemptions involve private placements, municipal securities, not-for-profit securities, new crowd-funding and Regulation A offerings, and franchise offerings.  Thus, heightened audit procedures will be the rule rather than the exception, applying in some form to both private and public capital raising efforts.

SAS 133 will apply when an auditor is “involved” in an exempt offering.  Being involved has two components: (1) the auditor’s report is included or referenced in the exempt offering document and (2) the auditor performs specific activities with respect to the offering document like reading the offering materials, offering a comfort letter, or agreeing to allow the use of the report in connection with the offering.  These requirements are designed to protect auditors from fallout from the use of their audits in connection with exempt offerings without their knowledge.
Among other things, SAS 133 will import the requirements AU-C Section 720 regarding “other information in documents containing audited financial statements” and AU-C Section 560, which requires auditors to consider whether events after the report would cause the auditor to revise the report.

This new auditing standard will require auditors to pay attention to two related developments.  First, auditors will have to be more attuned to which transactions count as securities.  For example, the SEC recently decided that offering cryptocurrency is a securities offering requiring registration or exemption.  Second, auditors will have to consider how closely to hue to GAAP and the FASB’s auditing standards, which are not yet mandatory but do influence how disappointed investors seek redress for failed investments.  For more information on non-GAAP accounting and the state of the industry, see our video here.

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Does Your Business Policy Actually Protect You? If it has a “Professional Services” Exclusion, it might not

If you did not believe it before, you can believe it now—Ponzi-scheme cases make bad law.  On July 5, 2017, the Eleventh Circuit decided Furr v. National Union Fire Insurance Company of Pittsburgh (No. 15-14716), in which the court considered the impact of a “professional services” exclusion in a bank’s executive and organization liability insurance policy.*  The court held that there was no coverage for anyone because some of the claims asserted were related to the professional services that the bank rendered to the Ponzi scheme.  In denying coverage to everyone, the court reviewed this exclusion:

The Insurer shall not be liable to make any payment for Loss in connection with any Claim made against any Insured alleging, arising out of, based upon, or attributable to the Organization’s or any Insured’s performance of or failure to perform professional services for others, or any act(s), error(s) or omission(s) relating thereto.

The court upheld coverage denial (1) because the policy did not contain a severability provision and (2) because the text of the exclusion prohibited payment if a claim is made against any insured who performed or failed to perform professional services.  To be clear: if anyone was a professional subject to a claim (or performing professional services), no one gets coverage, even non-professionals.

This has two important consequences: First, if a claim is made under a policy with similar contents, then claiming a legal, accounting, or medical error will jeopardize coverage for everyone.  Second, and perhaps more importantly, this particular policy evidently does not protect a bank from claims arising from banking services because those services are professional enough to be encompassed by the exclusion.

Exclusions like the professional services exclusion (and the personal injury exclusion) are designed to keep claims inside the appropriate policy and preclude doubling-up on coverage across multiple policies.  That is fair.  A D&O policy shouldn’t cover personal injury—that is the role of the general liability policy.  But excluding coverage based on a bank’s banking services seems to have left the bank’s executives without any coverage.  That is a harsh result.

I do not mean to sound shrill, but everyone should look at their policies and make sure that they actually have the coverage that they intend to have both from the perspective of whether the company’s services would be included in the “professional services” exclusion and to make sure that an errant claim touching on a professional’s work inside the business does not jeopardize coverage for everyone.

_____

* I have not actually seen the policy, but this “executive and organizational” policy sounds more like a Director & Officers (D&O) policy than an Errors and Omissions (E&O) policy.

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Can you name Justice Kennedy’s 2017 Term-Ending 5-4 Blockbuster?

On June 26, 2017, the Supreme Court decided CalPERS v. ANZ Securities, Inc., in which it declined to create a judicial exception to the statute of repose in Section 11 cases arising under the Securities Act of 1933.  When Congress passed its cornerstone securities laws in 1933 and 1934, it created an express cause of action against misrepresentations made in connection with the initial offerings of securities.  That cause of action was limited by a two-tier time limitation system: a one-year statute of limitations running from discovery of the misrepresentation and a three-year statute of repose running from the issuance of the security.  Steamy stuff, right?

CalPERS, California’s state pension entity and frequent securities plaintiff, decided to opt-out of a timely class action to file its own separate suit outside of the three-year statute of repose.  In 1974, the Supreme Court had created a form of equitable tolling of antitrust claims relating to individual suits and class-actions.  In this case, the Supreme Court said that American Pipe involved tolling a statute of limitations, which courts can do, but that courts were not permitted to toll a statue of repose.

Three lessons here:

  1. New public companies can have confidence that they will not face new Section 11 suits following three years from their IPO.  Definitely a cupcake worthy day to calendar for companies accepting public capital.
  2. Parties should be very careful in leaving class actions.  Instead, they can consider a request to be added as a named plaintiff or other procedural decides inside a timely suit.  (And lawyers should study the difference between a statute of limitations and a statute of repose.)
  3. Not everything that happens in the Supreme Court in June involves an existential crisis.

The opinion is available in full:  https://www.supremecourt.gov/opinions/16pdf/16-373_pm02.pdf.

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Retrospective on Recent Enforcement Trends and Insights on Where the SEC Might be Heading

On May 31, 2017, Former SEC Chair, Mary Jo White and former SEC Director of Enforcement, Andrew Ceresney presented a retrospective on recent enforcement trends and their insights on where the SEC might be heading. Here are a few takeaways:

1.   SEC enforcement actions are on the rise. From 2013 through 2016, 2,850 enforcement actions were filed. Judgments and orders over this period totaled more than $13.8 Billion. The use of big data contributed to the enforcement division’s increase in activity.

2.   The number of enforcement actions involving accounting firms and auditors is also seeing an upward trend. From 2013 through 2014, the SEC brought 37 Rule 102(e) proceedings against accountants for improper professional conduct. That number rose to 76 proceedings from 2015 to 2016.  The alleged improper conduct in these proceedings arose from claims of audit failure or independence violations. The SEC sees auditors as gatekeepers and partners in protecting investors and the integrity of the markets.

3.   The SEC’s numbers show a steady increase in financial reporting cases since 2013. From 2013-2014, 53 financial reporting cases were filed and 128 parties were charged. From 2015-2016, those numbers increased to 114 financial reporting cases and 191 parties charged. Despite the increase in cases, the SEC hasn’t uncovered any massive fraud cases on the level of Enron and WorldCom. Ms. White and Mr. Ceresney attribute this to improved financial reporting and internal controls promoted by Sarbanes Oxley.  The SEC would likely reconcile the touted effectiveness of Sarbanes Oxley with the increase in enforcement actions by arguing that regulations have deterred major crimes, allowing the Commission to focus on enforcing other violations.

4.   We can expect to see some changes with the new leadership. The new chair, Jay Clayton, appears focused on capital formation. Consistent with the overall focus on reducing regulation, Chair Clayton has expressed a desire to reduce barriers to going public. This may lead to an increase in enforcement activity around initial public offerings.

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Three Take-Aways from the PLUS Seminar on Mediating Complex Director & Officer (D&O) Claims

Three Take-Aways from the PLUS Seminar on Mediating Complex Director & Officer (D&O) Claims:

  1. Mediation is not a day-of event.  Counsel are well served to work very hard before the mediation to set expectations of parties, carriers, other counsel (including coverage counsel), and the mediator.  The panel noted that, even when a mediation is conducted in person, plaintiffs and carriers often have a range of authority that can be difficult to alter the day of mediation.  Surprises at mediation frustrate the process and do not materially advance settlement potential.  Counsel for all sides must engage constituent decision makers so that they are well informed and understand the risks so that they can bring appropriate authority to a mediation.
  2. Informational asymmetries may hinder the mediation process before, during, and after a mediation.  Participants need to understand what risk plaintiffs are presenting in a case. Defendants must offer honest assessments to carriers—it does not help to tell a carrier that there is no liability throughout a case and then ask for a large check in mediation.  Likewise, if you expect coverage to play a role in the negotiation, in most cases it makes sense to brief the mediator and plaintiff so that they can factor a coverage issue into their calculus.  Finally, no one is scared by a plaintiff or defendant who says they have a persuasive case but is reluctant to present detailed facts about the elements of a claim. 
  3. Defendants should be up-front with insurers about their settlement preferences.  Broadly speaking, litigants fall into two camps at a negotiation: (a) pay a plaintiff as much as needed to end litigation today and (b) pay defense counsel as much as needed to defeat the claim.  While the party’s attitude towards settlement won’t be dispositive of the carrier’s willingness to negotiate, it will inform the carrier’s authority and attitude about the case.  Psychology matters more than people care to admit.
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Did the Georgia Legislature Just Delete the Corporate Duty of Loyalty?

On May 9, 2017, Governor Deal signed House Bill 192 into law.  For claims arising after July 1, 2017, O.C.G.A. §§ 14-2-830(a) (directors); 14-2-842(a) (officers) will provide:

A [director or officer] shall discharge his perform his or her duties as a [director or officer], including his duties as a member of a committee: (1) In a manner he believes in good faith to be in the best interests of the corporation; and with the degree of (2) With the care an ordinarily prudent person in a like position would exercise under similar circumstances. 

That strike through of “to be in the best interests of the corporation” is pretty stark, right?  Perhaps all of an officer’s or director’s duty of loyalty to a company will be placed in the duty of good faith.  But perhaps the legislature wanted to bar an end-run around its duty-of-care enactment by narrowing the statutory duty of loyalty to violations of O.C.G.A. § 14-2-861(interested party transactions) and O.C.G.A. § 14-2-832 (unlawful distributions), which are still prohibited.  Time will tell…

The main thrust of the legislative amendment was to enhance protections for corporate decision making by adding this text:

There shall be a presumption that the process [a director or officer] followed in arriving at decisions was done in good faith and that such [director or officer] has exercised ordinary care; provided, however, that this presumption may be rebutted by evidence that such process constitutes gross negligence by being a gross deviation of the standard of care of [a director or officer] in a like position under similar circumstances.

O.C.G.A. §§ 14-2-830(c) (directors); 14-2-842(c) (officers).

These amendments are a response to FDIC v. Loudermilk, in which the Georgia Supreme Court held that the substance or wisdom of a corporate decision was unreviewable in court absent gross misconduct.  295 Ga. 579, 581 (2014).  But the Court also held that in order to obtain deference for their decisions, corporate actors’ process for making their decisions was reviewable under a simple negligence standard: officers and directors “may be liable for a failure to exercise ordinary care with respect to the way in which business decisions are made.”  Id. at 593.

In amending the statute, the legislature addressed the obvious point that deference to ultimate corporate decisions is of little value if the there is no deference to the decision-making process.  Once this law is in effect, corporate officers and director are presumed to have acted in good faith in the process used to make business decisions.

If you want to know more, look out for a more in-depth treatment in our next firm newsletter.

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Takeaways from Ascent 2017 Conference – Atlanta

I had the pleasure of attending the Ascent 2017 Conference in Atlanta, on invitation from Sloane Perras, Chief Legal Officer for The Krystal Co. & On The Border Mexican Grill & Cantina and one of the conference organizers.  The conference was a great success and brought together more women in-house and outside counsel at one time than any other event I’ve attended.  A few points I took away:

  1. Pay equity, diversity, and social awareness are all being embraced by many large companies, with the view that those policies raise all boats.  These companies are using their leverage to encourage adoption of these initiatives by their vendors and outside counsel.
  2. To be a successful partner as outside counsel, we must understand the client’s business above all else: the financials, the product lines, the risk factors, and the business objectives.  Both inside and outside counsel must find and capture the tone that will speak to the decision-makers while uncovering any blind spots or potential liabilities not considered.
  3. Data breaches remain front of mind for many.  The alphabet soup of regulations, laws, and governing watch-bodies that might be implicated in any given industry continues to grow.  Class action lawyers stand at the ready to push the bounds of what constitutes damages.
  4. Leaders must create a culture of compliance.  The risks of not doing so far outweigh the costs.
  5. Finally, when pushing for change, leaders must be unafraid and confident in their decisions.  Innovation must be balanced with risk management; if you understand the core of the problem and have a vision for moving forward, you can convince stakeholders change is necessary.
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Takeaways from State of the LPL Market Panel Presentation at ABA National Legal Malpractice Conference 2017

Takeaways from State of the LPL Market Panel Presentation at ABA National Legal Malpractice Conference –  Boston 2017

  1. Big Data is changing Underwriting, Broking and Claims Handling and helps to keep the LPL and APL markets highly competitive and insurance reasonably priced.
  2. P & C events, such as Hurricanes in the Caribbean, no longer  drive rates up for Lawyers and Accountants because carriers now distinguish between Casualty and Professional Liability risks.
  3. The Great Recession, the largest economic crisis in 70 years, created a hard market that only lasted about six weeks.
  4. Capital to insure professionals keeps pouring into the market, despite an increase in huge claims individually exceeding hundreds of millions of dollars.
  5. Despite all the positive developments, premiums have increased between 2 and 4% on average for Lawyers E and O insurance in 2017.  While 20 years ago this would have been classified as an annual inflation adjustment, now  it may be the closest thing we will see to a hard market for some time.
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Sometimes You Shouldn’t Settle

Billy Newcomb and I recently won summary judgment for a top 100 accounting firm. A publicly traded company had sued in a Florida court, alleging negligent failure to detect fraud and claiming damages well into eight figures. Six other defendants, including a top 10 accounting firm, settled with the Plaintiff just after suit was filed, leaving our clients as the sole defendants. At court-ordered mediation, the Plaintiff, perhaps a little too confident in its home court advantage, refused to lower its demand under $5 million. Immediately after the mediation failed, the trial court granted summary judgment to CCS’ clients and dismissed all of the Plaintiff’s claims with prejudice.

Billy practiced law in Florida for five years and regularly litigates Florida cases, and he and I have done well in Florida over the years. We felt strongly about our liability and damages defenses and didn’t want to waste our clients’ money on an excessive settlement. Our clients agreed and had the confidence to stand up to the Plaintiff. If early summary judgment had not been granted, Billy and I planned to prevail on another dispositive motion or at trial.

When a Plaintiff makes a reasonable demand, we often recommend settlement to our clients. But, when the plaintiffs are unreasonable, we know how to get a better result at the courthouse.

As Churchill announced:

we shall fight on the beaches,

we shall fight on the landing grounds,

we shall fight in the fields and in the streets,

we shall fight in the hills;

we shall never surrender…

There are no sure things in litigation, but if you want to know what a case is worth, sometimes you must have the courage to fight. We are both very grateful to our clients for their courage in letting us go forward.

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