November 3, 2003
Do Firms Owe Fund Execs Indemnity in Fund Scandal Suits?
Fund executives who have already been cut loose in the first wave of firings in the mutual fund scandal may find themselves legally hung out to dry by former employers looking to save face and distance themselves from the wrongdoers.
Not only are they out of a job, but they may find themselves on their own to face mounting legal fees, angry regulators and possible jail time. In most cases, especially with lower-level employees, firms have limited or no responsibility to pay for legal fees, especially when the individual is likely guilty of wrongdoing, several lawyers said.
"Unless you have some type of an employment agreement that requires the firm to reimburse your costs, it's very difficult to compel the firm to pay your fees," said Melanie Cherdack, of-counsel at the Miami-based law firm Genovese Joblove & Battista. Those agreements are generally reserved for the high-ranking officers of a company, she said. "If the firm doesn't feel the employee has done anything wrong, they generally will pay for the counsel," but the Theodore Sihpol III situation is different, she said.
Sihpol, the former Bank of America broker responsible for executing illegal trades between BofA's Nations Funds and New Jersey-based hedge fund Canary Capital Partners, thinks differently. He claims his former employer is leaving him legally high and dry and filed a complaint late last month in a Delaware Chancery Court seeking payment of his costs related to the investigations.
"Mr. Sihpol is facing criminal and civil proceedings arising out of activities he allegedly undertook for the Bank of America, of which his was an officer and employee," said C. Evan Stewart, Sihpol's lawyer. Sihpol has said he already has incurred $130,000 in legal fees and anticipates more to come. He faces up to 25 years behind bars on one count of grand larceny and possibly four more years for one count of fraud.
BoA declined to comment for this story, and it is unclear what path other firms are taking with their casualties. Merrill Lynch, Putnam Investments, Smith Barney and Alliance Capital either failed to return phone calls by press time or issued a "no comment." Janus said it has not announced any dismissals related to the investigation and couldn't comment. However, it has been reported the firm fired an undisclosed number of employees related to the probe.
Sihpol's case rests on his right to indemnification, as per the BoA bylaws, according to the complaint. Indemnification, or compensation, is owed to every person involved in an action, suit or proceeding, by the fact that he or she served as a director, officer or employee of the firm or at the request of the firm or business partner, according to BoA bylaws, as presented in Sihpol's complaint.
Sihpol is asking BoA to advance attorneys' fees and expenses relating to the Securities and Exchange Commission's administrative proceeding against him, as well as legal fees and expenses in connection with three civil proceedings. Additionally, he anticipates being named a defendant in more criminal and civil actions, and may be called as a witness in a number of other cases.
The BoA bylaws also state that an individual "shall be indemnified and held harmless by the corporation to the fullest extent authorized by the DCGL (General Corporation Law of the State of Delaware)." It also has provisions that protect employees "against all expenses, liability and loss reasonably incurred or suffered."
Cherdack, a former in-house attorney at Paine Webber, said that although firms will pick up the tab in some instances, the majority of the time it is their choice - not a legal obligation. However, she added, "In the real world, companies that are being sued or investigated usually like to have employees cooperate with their own internal investigation" Thus, like one hand washing the other, a firm might pick up the tab on legal fees in return for the employee's cooperation. If it is determined that there may be a conflict of interests, with the firm possibly planning to sue the employee at some point down the road, the firm may hire a separate lawyer for the employee, so that it can still maintain some control over the process.
Cherdack said that she believes BoA's choice not to cover Sihpol is a public relations decision, particularly with all the scrutiny on BoA and the egregious accusations against Sihpol.
"It's a complex issue," said Bill T. Singer, a partner in the broker/dealer practice group at Gusrae, Kaplan & Bruno of New York. "The issue with legal fees is a creature, in some cases, of state law and, in others, of contract law," Singer said.
Close to the Vest
He said firms might want to keep employees or former employees who are now under the microscope, close to the vest. "They are more likely to cut deals and be flipped against the firm if they have an outside counsel. Firms such as Smith Barney and Merrill Lynch, after laying off a number of brokers and now the scandal, are in a difficult spot. Many of the brokers are so ticked off, they may sit and join ranks against the firm."
In-house investigations are going to have to happen far more zealously because directors have much more at stake, he said. And firms may have a harder time shelling out dough for legal representation for those who have committed crimes. "If a firm finds a person engaged in wrongdoing now, they have to justify why they provided counsel. Now they have to issue a report to shareholders and the board. It may be more appropriate to fire the guy now. You can't close ranks anymore."
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