OFAC Violations: A New Potential Source of D&O Liability Exposure?

In a lawsuit suggesting a new area of potential liability for corporate directors and officers, a shareholder of J.P. Morgan Chase has filed a derivative lawsuit against the company, as nominal defendant, and certain of its directors and officers alleging breaches of fiduciary duty in connection with the company's recent $88.3 settlement with the U.S. Department of Treasury's Office of Foreign Assets Control (OFAC). A copy of the derivative lawsuit complaint, filed September 6, 2011 in the Southern District of New York, can be found here.

OFAC is responsible for the administration of various trade sanctions regulations. In an August 25, 2011 press release, OFAC announced (here) that J.P. Morgan had agreed to pay $88.3 million to settle alleged violations of U.S. trade sanction regulations. Among other things, the OFAC press release described three alleged violations it characterized as "egregious." Among the programs that OFAC alleged that the company had violated are those involving sanctions against Cuba, Iran and Sudan. The OFAC press release described the settlement as the largest settlement to date obtained by OFAC.  

On September 6, 2011, the Louisiana Municipal Police Employee Retirement System filed a derivative lawsuit in the Southern District of New York, naming eleven directors and officers of J.P. Morgan as defendants. The complaint alleges that the defendants "knowingly allowed and rewarded the Company's violations of The U.S. Department of Treasury's multiple sanctions programs." The lawsuit alleges that "the misconduct occurred, unchecked, under the Defendants' watch because of their complicity in the improprieties alleged herein." The lawsuit seeks to "recover damages caused by the Individual Defendants' unlawful course of conduct and breaches of fiduciary duty." Among other damages alleged are "the costs to the Company associated with the settlement, remedial measures, damage to goodwill and increased regulatory scrutiny."

As reflected in a September 23, 2011 memo from the Fried Frank law firm entitled "State Pension Plan Files Claim Seeking $88.3 Million OFAC Penalty" (here), among the implications of these developments is that "OFAC violations can have significant follow-on consequences for not only the company --- but officers and directors as well." The payment of a settlement "sometimes is just the beginning," as a settlement "can spark the attention of shareholders and result in the filing of a derivative lawsuit to hold officers and directors liable for repayment of any amounts paid in settlement."

The prospect of a follow-on civil lawsuit following a civil settlement for OFAC violations raises a number of interesting challenges, particularly from an insurance standpoint. The settlement amount itself would not be covered under the typical D&O policy. The defense costs the defendants incur in a follow-on civil lawsuit would likely be covered. The interesting question comes in with respect to the damages alleged in the follow-on lawsuit. The question of the coverage for the alleged damages is analogous to the damages claimed in the follow-on civil actions filed following companies' payment of Foreign Corrupt Practices settlements (about which refer here).

The complaint itself in this action actually has some things to say about D&O insurance. In arguing that its failure to make a pre-litigation demand on the J.P. Morgan board ought to be excused as futile, the plaintiff argues among other things that if the board were to sue themselves or other officers in connection with the OFAC violations, the claim would run afoul of the D&O policy's Insured vs. Insured exclusion and therefore "there would be no directors' and officers' insurance protection" which is a "reason why they will not bring a suit." The complaint notes that the Insured vs. Insured exclusion will not apply if the suit is brought derivatively.

Although the Insured vs. Insured exclusion would not apply to the plaintiff's derivative suit, it remains an interesting question of what position the carrier would take with respect to the damages that the plaintiff seeks to recover. In any event, the lawsuit raises the possibility of a potentially significant new liability exposure for directors and officers of company's engaging in transactions subject to OFAC's oversight.

Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.

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