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The author is a partner with Jenner & Block LLP, Chicago.
To: Stephen Armstrong, Personal Counsel for Hank Kauffman
From: Ron Marmer
Re: Kauffman Personal Defense
Hank will need to make some preliminary assessments about who his natural allies are, where he will have to go it alone, and where he faces the most risk.
Two items are always on my list of early topics to cover, and we should raise them with Hank right away. The first is the duty to preserve documents, both paper and electronic. We should explain that electronic documents include information on home computers, BlackBerrys, and iPhones. Here, there is a specific statutory obligation under the Securities Litigation Reform Act to preserve documents. Even without that, it always makes sense to do so.
The second topic is insurance. Hank needs to learn what kind of insurance coverage he has, and he needs to provide timely notice to all the insurance companies that might be asked to respond. The likely sources for Hank are a D&O policy at GyneTech, a D&O policy from his own hedge fund, and some individual policies he might have. Someone at GyneTech and someone at Hank’s fund should consult insurance-coverage counsel to be sure all the potential sources for insurance have been identified and all those companies have received proper notice. We will want to get copies of the applicable policies and copies of the notices that have been sent. We also will want copies of GyneTech’s articles of incorporation and bylaws to confirm that the company provides both advancement of defense costs and indemnification for Hank. We should be able to get the same information from his hedge fund.
We need to know what outside resources are available to Hank and the other defendants, because those resources will dictate other strategic decisions. For example, Hank may need to hang on to as much insurance as possible to fund defense costs on the many fronts. With this many individuals looking for coverage, defense costs are going to eat up a D&O policy at a brisk clip.
As we look at all the folks who are involved, the other independent directors are Hank’s most likely natural allies. But when Hank’s hedge fund decided to launch a proxy contest for GyneTech, Hank set himself apart from the other independent directors. He needs to keep you involved as his personal lawyer, and we will have to work to maintain good relations and close coordination with the other independent directors.
The proxy contest also raises another sensitive issue for Hank. He will have to recuse himself from participating in any discussions or votes that could affect the proxy contest. The independent directors likely will create a separate committee that does not include Hank, but this does not mean Hank cannot make sensible suggestions on how GyneTech should deal with the DOJ, FDA, and SEC. Indeed, Hank should be urging GyneTech to conduct a careful investigation and adopt a cooperative approach with government regulators.
To assess risks, it always makes sense to get as much of the story as we can from the client. We want to hear, in Hank’s own words, whatever he thinks he should tell us. The hardest part for us will be not to interrupt. We always can go back over the information to clarify and explore key points later. We also will want to take a look at the most significant documents to pin down dates and to see whether there are new or different facts that we need to discuss in another session.
My own internal note of caution is to guard against accepting as accurate a sincere narration that appears to be consistent with high-level documents. Three or four witnesses who remember the same thing, plus a dozen high-level documents that are consistent, can be a very tempting package to summarize, tie up with a bow, and accept as the accurate historical record. That would be a mistake. It isn’t that everyone gets together and decides to come up with some made-up account. The problem is that groups often develop a shared recollection of how things happened, and the members of the group reinforce and reconfirm those views over time, even though their shared recollection may be at odds with what really happened. We eventually may need some targeted legal research, but we definitely need some very intense factual research—the sooner, the better.
From the facts we know now, Hank’s primary risk concern is the easiest to spot. Hank is not looking at serious criminal exposure, but he has to take some steps to ensure he doesn’t become a target. Although Diana Gray’s death and the purging of personal files from her computer raise criminal concerns, those do not pose real risk for Hank. The main issue for Hank is whether he will face some criminal exposure for failing to fulfill responsibilities to report to the FDA. Because of the article in the Wall Street Journal, the FDA will be all over the company. Hank has to have a clear written record that he fulfilled his obligations; he has to have a good answer when he is asked why the board did not notify the FDA.
If Hank does not have a good answer now, he needs to get legal advice right away about whether the board must do more. A likely next step is for us to write a letter requesting a meeting of the independent directors so that we can chart a course that includes GyneTech’s cooperating fully with the FDA’s inevitable investigation. Hank also should suggest that the independent directors retain outside counsel, assisted by an outside expert medical and testing consultant, to help the independent directors learn about what happened in the study and who knew what. The independent directors may not let Hank inside their tent because of the proxy contest, but Hank should make the right suggestions about what should happen next.
Hank also faces some risk of criminal exposure for securities fraud, based on the Form 10-Q that the company filed. Hank likely will get a pass on that because the facts do not suggest he played a direct role in having the Form 10-Q filed with no changes. Hank can say that the independent directors did not know the true facts, the Form 10-Q was due, and it was premature to disclose allegations and rumors. If Hank acts promptly to set things straight, he should be fine.
Hank’s next concern isn’t in the facts, but it is about to show up. This kind of high-profile scandal is likely to attract political attention, and Hank can expect to be called to testify before a congressional committee. He therefore needs to be thinking now about where he will position himself in the public hearings. As an independent director launching a proxy contest, Hank almost certainly will want to take the position that he had no idea about the allegations of wrongdoing until Diana Gray’s email arrived; that he immediately scheduled a meeting of the independent directors; and that when he learned the basic facts, he concluded that management should be tossed out. That is why the board summarily suspended Bass with pay, and that is why his company launched a proxy contest. It is important for us to make Hank understand that if he is called to testify before a congressional committee, he has only two options: to answer the questions truthfully or to take the Fifth. Because the setting is political, Hank will have very few protections and lots of temptations. He will want to give the answer that makes the most sense politically, but the dynamics in that political setting cannot obscure the fundamental reality that he will be testifying under oath.
The state attorney general also may want to get involved, but the AG’s office most likely will be chasing parts of the scandal that do not touch Hank. The same is true of the state’s attorney.
The SEC also will launch its own investigation; it is unlikely the SEC will defer to the DOJ or the FDA, especially on matters relating to the filing of the Form 10-Q and the proxy disclosures. Because Hank runs a hedge fund, and because the SEC now has substantial authority over hedge funds, Hank must think of the SEC as his primary regulator. He has low exposure with the SEC, but he has a broader relationship to protect. Hank needs to turn square corners in all his dealings with the SEC. The strategic challenge is that the SEC will take testimony before the private litigation reaches discovery, and that testimony will lock in witnesses at a very early stage in the factual development. Hank may not be asked to testify, but we cannot count on that.
The class actions obviously are important, but they are pretty far down the priority list. As a practical matter, it will take months before the court appoints class counsel, the parties brief the inevitable motions to dismiss, and the court rules on them. The plaintiffs will take a stab at getting discovery before the motions to dismiss are decided, but the court isn’t likely to allow it. The most common variation, which also typically fails, is for the plaintiffs to ask that the defendants immediately produce the documents that the defendants have gathered and produced to the SEC or other regulators.
If the plaintiffs survive a motion to dismiss, Hank and the other defendants will have to decide whether they should ask the court to address class certification before proceeding with merits discovery. That decision depends on whether the defendants have strong grounds to defeat a class, such as attacks on whether GyneTech stock trades in an efficient market.
Hank also can expect to be sued as part of the proxy contest. GyneTech may want to oppose his proxy contest, and that often involves a federal action challenging the proxy disclosures. With Bass gone, there may not be a strong personality to mount that kind of defense. MedaStar also may decide to sue as a tactic to advance its own proxy bid. Both GyneTech and MedaStar know that if they sue, they will be hit with counterclaims. But if GyneTech or MedaStar believes litigation is inevitable, one of them may choose to sue first to select the forum.
GyneTech’s outside auditors also will be demanding answers, and the auditors will expect to hear from outside counsel about the results of the internal investigation.
Let me know when you and Hank are available to meet. I will circulate a bullet-point agenda before we do.