Professional Liability Magazine - November 2018

NOVEMBER 2018

IN THIS ISSUE I N S I G H T: H I D D E N T H R E AT FO R E M P LOY E R S

BACK TO BASICS

Do You Really Know What the Dark Web Means?

W h a t Co n s t i t u t e s ‘ P r o f e s s i o n a l S e r v i c e s’ ?

S P OT LI G H T: H O W LI K E LY T O S U CC E E D

T H E # M E T O O PA R A D I G M — PA R T I I

A R E T R E B L E - D A M A G E A N D AT T O R N E Y- F E E

M a n a g i n g Co r p o r a t e D & O Li a b i l i t y

C L A I M S A G A I N S T LI C E N S E D P R O F E S S I O N A L S ?

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NOVEMBER 2018

EDITORS

CONTRIBUTORS

Jonathan S. Ziss

Andrew Carroll acarroll@goldbergsegalla.com

Management and Professional Liability Practice Group Chair

267.519.6820 jziss@goldbergsegalla.com

Todd D. Kremin tkremin@goldbergsegalla.com

Peter J. Biging

Matthew S. Marrone mmarrone@goldbergsegalla.com

Management and Professional Liability Practice Group Vice Chair

646.292.8711 pbiging@goldbergsegalla.com Kristin Klein Wheaton 716.710.5805 kwheaton@goldbergsegalla.com

Shannon T. O’Connor soconnor@goldbergsegalla.com Joseph A. Oliva joliva@goldbergsegalla.com Joanne J. Romero jromero@goldbergsegalla.com Colin B. Willmott cwillmott@goldbergsegalla.com Heather M. Zimmer hzimmer@goldbergsegalla.com

PLM | NOVEMBER 2018 INSIGHT 4 | Hidden Threat for Employers Do You Really Know What the Dark Web Means?

7 | Back to Basics What Constitutes ‘Professional Services’?

SPOTLIGHT 8 | How Likely to Succeed Are TrebleDamage and Attorney-Fee Claims against Licensed Professionals?

12 | The #MeToo Paradigm — Part II In this new era, corporate America must seriously consider the risks presented by sexual harassment by corporate officers and directors — and what needs to be done to manage this risk.

CASE NOTES 16 | How to Legally Dispel a Stereotype 17 | Computer-Crime Coverage: Are Changes on the Horizon?

18 | Real Experts Needed as WebsiteAccessibility Actions Gain Momentum

INSIGHT

Hidden Threat for Employers Do You Really Know What the Dark Web Means?

Shannon T. O’Connor

We engage with the deep web daily. It’s what is stored in a website’s internal database, anything not indexed, data a search engine canMost of the web is invisible to Google, which not find. It’s a user accessing his or her password-protected bank seems hard to fathom in a world where “Google it” account, email account, or workplace intranet page. It’s a query in is the answer to so many questions. For public and a website search box. private employers alike, daily operations and business activities that use online resources expose The dark web, sometimes called darknet, is a small slice of the a treasure trove of information to unintended users. Employers’ deep web intentionally hidden from search engines. To access the dark web, users must install special software on their comlack of understanding of the various levels of the web leaves them puters. The most common software downloaded to access and with inadequate safety measures to protect employee informanavigate the dark web is “The Onion Router” of Tor. Tor assists tion, company secrets, and proprietary information. Worse yet is in masking the user’s IP address. In addition, Tor routes traffic the threat of employees using employer computers to engage in through a series of volunteer nodes, which are hosted on the Tor illegal or nefarious activities. network. This process is random, and data bouncing through varEnter the “dark web,” a nebulous realm that employers univer- ious nodes makes it virtually impossible to trace. sally fear but rarely understand. How can an employer guard against risks associated with the dark web without even knowing what that means? Managers, executives, and HR professionals do not need to be IT experts (that’s what an IT department is for), but they do need to know commonly used terms and develop enough of a basic understanding of their networks to develop internal policies and procedures that protect against various cyber-security risks.

Definitions in the cyber world typically are confused or used interchangeably, as if they are synonymous, even by so-called experts.

This occurs even at a very elemental and foundational level when it comes to the IT world. For example, most people use the terms “Internet” and “web” as if they were synonymous. Technically, however, the Internet is the infrastructure connecting one computer network to another for the transportation of content, while the web is the software connecting the individuals using the computers—software that lets them access the content or contribute their own. The web runs over the Internet and is what you see and click on with your browser.

Total anonymity rules the day on the dark web. Still, basic economic principles of supply and demand apply equally to the various markets operating on the dark web, and disgruntled employees may use it to get back at their employers. It is not hard to imagine a scenario where the rogue employee seeks to make up for the pay raise he or she was denied by selling employer information. Notably, an employee could be recruited to access company personnel information, such as social security numbers, credit card numbers, or other confidential financial information in high demand on the dark net.

Advancements in technology continue to permit those with nefarious objectives to stay ahead not only of employers, but also of law enforcement, which in turn means that internal measures are currently the only method of preventing such misuse.

Getting to the right solution first requires that you frame the issue properly. The deep web and dark web are not synonymous, the terms not interchangeable. Inaccurate or confused definitions, a misunderstanding of the various layers or levels of the activity over the web, and ignorance of the corresponding or potential threats within each layer can lead to faulty policies, which in turn Various layers of the web operate over the Internet. The average likely would produce inherently flawed solutions. employer, like most other people, usually operates in the surface web, which is all indexed search engines such as Google, Yahoo, Policies and plans driven by a basic understanding of the various or Bing. Some studies estimate that the surface web contains over layers or levels of the web accessible by an employee via an em4 billion indexed websites. Although this seems exorbitant in size, ployer’s Internet network can go a long way toward prevention experts believe that the surface web is less than 1 percent of the and, even more important, toward the detection in some instancweb. The much larger portion is the deep web. es of unauthorized web use to the detriment of the employer. 

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INSIGHT

Back to Basics What Constitutes ‘Professional Services’?

Colin B. Willmott The modern insurance industry offers many lines of coverage for various risks, and insurers work hard to eliminate overlap.

Between these coverage areas, there are many stress points that insurers and policyholders repeatedly confront.

One is the dividing line between risks covered by commercial general-liability, or CGL, policies and those covered by professional-liability policies.

out of a vocation, calling, occupation, or employment involving specialized knowledge, labor, or skill, and the labor or skill involved is predominately mental or intellectual, rather than physical or manual.” Marx v. Hartford Accident & Indem. Co., 157 N.W.2d 870, 872 (Neb. 1968). So, a professional-services exclusion is based not on the title or character of the party performing the act but, rather, on the nature of the act. Id. at 872. In other words, the professional-services exclusion is not limited to prohibiting coverage to members of certain professions, such as doctors, lawyers, and engineers. In fact, this exclusion is often interpreted broadly, and courts have used it to bar coverage for a wide range of conduct. See, e.g., Amex Assurance Co. v. Allstate Ins. Co., 112 Cal. App. 4th 1246 (Cal. Ct. App. 2003) (plumbing); Hollingsworth v. Commercial Union Ins. Co., 208 Cal. App. 3d 800 (Cal. Ct. App. 1989) (ear piercing).

CGL policies generally cover risks associated with bodily injury and property damage that the policyholder causes to a third party. In contrast, professional-liability policies focus on covering lawsuits brought against the insured in connection with the rendering of professional services. Cognizant of the potential overlap between these two kinds of policies, insurers providing CGL coverage often The professional-services exclusion, however, is not automatically applied to work just because it’s performed by a professional. include exclusions barring coverage of “professional services.”

See Am. Family Mut. Ins. Co. v. Enright, 781 N.E.2d 394 (Ill. App. Ct. The question, then, is where to draw the line. CGL insurers must 2002) (negligent hiring leading to sexual assault). decide whether a particular set of facts falls under the professionalservices exclusion. In interpreting what constitute professional Due to the breadth of the professional-services exclusion, it has services, many courts follow a test formulated by the Nebraska proved to be an effective tool for insurers to compartmentalize risk Supreme Court, which defines a professional act as “one arising and therefore warrants serious consideration in many instances. 

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November 2018 | 7

SPOTLIGHT

How Likely to Succeed Are TrebleDamage and Attorney-Fee Claims against Licensed Professionals?

Matthew S. Marrone

CONSUMER PROTECTION LAWS

While state consumer-protection laws often are referred to as “Little FTC Acts,” there is actually considerable variation between state consumer-protection laws. Typically, states have either a) copied Section 5 of the FTC Act in its entirety; b) adopted all or part of three model state consumer-protection laws; c) copied the FTC or a model act but changed some of the wording; or d) combined two or more of these approaches. See Mark D. Bauer, The Licensed Professional Exemption in Consumer Protection: At Odds with Antitrust History and Precedent, 73 Tenn.L.Rev. 131-176 (2006) (citations omitted). Although the states have followed different paths in trying to protect consumers, there are very significant and strong commonalities between most, if not all, states.

Substantially, all these state laws can be traced directly to Section 5 of the FTC Act. Id. While Little FTC Acts are similar to the federal act, they differ from the federal FTC Act in one important way: With the exception of Iowa’s Consumer Fraud Act, all Little FTC Acts provide for private enforcement and private remedies, including, in about half the states, treble damages akin to the antitrust laws. Id.

The vast majority of states have consumer-protection laws. Courts across the country have debated whether these laws should apply to licensed professionals. Consumer-protection laws used in almost every state in the nation were drafted borrowing language from the Federal Trade Commission (FTC) Act. The most important connection between antitrust and consumer protection is Section 5 of the FTC Act, which the FTC uses to discharge both its antitrust and consumer-protection missions.

Whether the learned professions, such as doctors, lawyers, accountants, architects, and engineers, should be included under Little FTC Acts has been debated for years. In many ways, this debate has paralleled the one over whether these professionals were within the scope of the Sherman Act. The states where courts have found some or all professionals to be outside the scope of their Little FTC Act, however, have suggested more than one reason to exempt professionals.

Most professional-liability claims are based on ordinary principles of negligence, contract, or breach of fiduciary duty. But every now and then a plaintiff’s attorney will include a claim based on a statutory enactment that provides for recovery of treble damages, attorney fees, and costs of suit. The two most common statutory causes of action that are asserted against professionals are violations of: 1) state consumer-protection laws; and 2) Racketeer Influenced and Corrupt Organizations (RICO) Act, 18 U.S.C. § 1962. Perhaps the claims are asserted to strike fear in the hearts of the defendants, their insurers, or their defense counsel, with the hope that this extra leverage will provide incentive to settle. If successful, the claims can lead to significant damage enhancements and potential coverage issues. But do these claims have merit?

How likely are they to really succeed?

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1. Trade or Commerce Exemptions Similar to the FTC and Sherman Acts, the majority of states require that allegedly unlawful conduct under consumer-protection laws be made in “trade or commerce.”

Id. Substantially, all of the remaining states require the offending conduct arise from “trade.” Id. What constitutes “trade or commerce” is subject to debate.

For instance, in Short v. Demopolis, 691 P.2d 163 (Wash. 1984), the Washington Supreme Court held that an attorney’s conduct in the practice of law may not be “trade or commerce.” A billing dispute arose between a law firm and client concerning both the size of the bill and whether the client had agreed that two associates – rather than a partner – would work on the case. The client alleged a violation of Washington’s Little FTC Act. The Washington Supreme Court held that the learned professions are not part of trade or commerce; ergo, the practice of law cannot constitute trade or commerce under the Washington Little FTC Act. Id at 168.

Although the Washington Supreme Court did hold that “certain entrepreneurial aspects of the practice of law may fall within the ‘trade or commerce’ definition” of the Little FTC Act, it refused to recognize that all attorney conduct was trade or commerce. Id.

In Gadson v. Newman, 807 F.Supp. 1412 (C.D.Ill. 1992), an Illinois psychiatrist accused a hospital and another psychiatrist of deceptively creating financial incentives to admit patients to the hospital. While the court acknowledged that state-regulated professionals were not exempt from the FTC Act itself and that the Illinois Little FTC Act called upon courts to consult FTC precedent, the court found “[t]he medical and legal professions are afforded immunity from the (Illinois Little FTC Act) For instance, in Kessler v. Loftus, 994 F. primarily, because, unlike other commerSupp. 240 (D. Vt. 1997), a Vermont law firm cial services, medical and legal bodies are represented to a divorce client that her regulated by governmental bodies.” Id. at claims against her former spouse’s land 1417-1419. were “adequate security” for a debt that was owed, and that the firm committed to In Hampton Hospital v. Bresan, 672 A.2d 725 provide her with “competent representa- (N.J.Super. 1996), a New Jersey plaintiff altion,” neither of which she received. Id. at leged that a hospital inflated its medical 241. Although the court noted that it was bills by unnecessarily extending a patient’s required to construe Vermont’s Little FTC stay. Holding hospitals to be beyond the Act in accordance with FTC precedent, and scope of the New Jersey Little FTC Act, the that attorneys received no blanket exemp- court noted that hospitals were already tion from the law, the court held that rep- strongly regulated by the state department resentations of “adequate security” and of health. The court did not note, however, “competent representation” were legal whether this separate regulatory scheme opinions and not entrepreneurial. included a right of private action or multitermine the applicability of a Little FTC Act: If the licensed professional is engaged in an “entrepreneurial activity,” then the conduct falls within the ambit of the Little FTC Act; if the activity involves the learned profession itself, then the Little FTC Act does not apply. See Mark D. Bauer, The Licensed Professional Exemption in Consumer Protection: At Odds with Antitrust History and Precedent, 73 Tenn.L.Rev. 131-176 (2006) (citations omitted).

In Suffield Development Associates, L.P. v.

National Loan Investors, L.P., 802 A.2d 44 (Conn. 2002), a debtor alleged that a law firm fraudulently and deceptively tried to collect a debt. While the Supreme Court of Connecticut agreed that the law firm Other courts have indulged in more creabused the debt-collection process, the ative analyses. In trying to distinguish court denied relief under the Little FTC Act. antitrust cases concerning the learned Id. at 53. Although the debtor alleged that professions, the Illinois Court of Appeals the law firm sought to recover an amount in Frahm v. Urkovich, 447 N.E.2d 1007 (Ill. in excess of what was owed, the court Ct.App. 1983) suggested that such cases concluded it was not entrepreneurial and “dealt only with the commercial aspects instead may have been actionable profesof the legal profession through activities sional misconduct. which would have a direct effect on the consuming public and not with the prac- In a Tennessee case, Constant v. Wyeth, tice of law itself.” Id. at 1010. Although the 352 F.Supp. 847 (M.D.Tenn. 2003), a doctor court failed to describe the type of activity prescribed the drug Fen-Phen to a patient, that would involve the practice of law but and the drug was later withdrawn from the not have a direct effect on the consuming market because of concerns about serious public, it held that “trade or commerce” health effects. The court succinctly held did not include the actual practice of law. that doctors are immune from Tennessee’s Id. at 1011.

Little FTC Act when the “allegations concern the actual provision of medical ser2.Non-Entrepreneurial Activities vices.” Id. at 854.

Exemptions The jurisprudence underlying the afore- 3.“Regulated” Professions Exemptions mentioned cases perhaps set the stage for further distinction within the learned professions when determining whether consumer-protection laws apply. Several state courts have created a subjective test to de-

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Another reason that some state courts have chosen to exempt licensed professionals stems from the license itself, as some states’ courts yield to the regulatory scheme already in place for licensed professionals.

ple damages.

In New Hampshire, the state Supreme Court decided that attorneys and other professionals were exempt from the New Hampshire Little FTC Act because of vague wording exempting trade or commerce subject to a “regulatory board.” Rousseau v. Eshleman, 519 A.2d 243 (N.H. 1986). The New Hampshire Legislature has since repealed the relevant language, suggesting a legislative intent to include professionals with the New Hampshire Little FTC Act. 4.Practical Advice Courts have recognized there are many potential avenues to argue that licensed professionals should be altogether exempt from consumer-protection laws. If the claim has been asserted, chances are the jurisdiction is unclear, and it may be debatable whether the law should apply to the particular class of professional at issue, under the circumstances presented.

Defense lawyers must be knowledgeable of the law and how to best argue on their clients’ behalf that it should not apply.

RICO It is not uncommon for professionals — lawyers and accountants, in particular — to (continued on next page)

November 2018 | 9

be sued along with their clients by a third party alleging RICO violations. Such RICO actions are typically brought pursuant to 18 U.S.C. § 1962(c), which prohibits racketeering and unlawful debt collection, and 18 U.S.C. § 1962(d), which prohibits conspiring to violate one of the other RICO sections.

Section 1962(c) provides: It shall be unlawful for any person employed by or associated with any enterprise engaged in, or the activities of which affect, interstate or foreign commerce, to conduct or participate, directly or indirectly, in the conduct of such enterprise’s affairs through a pattern of racketeering activity or collection of unlawful debt.

18 U.S.C. § 1962(c).

Thus, in order to initially plead a violation of § 1962(c), plaintiffs must allege “(1) conduct (2) of an enterprise (3) through a pattern (4) of racketeering activity.” Lum v. Bank of America, 361 F.3d 217, 223 (3d Cir. 2004).

The Eleventh Circuit has helpfully aggregated the requirements for a civil RICO claim predicated upon mail or wire fraud: (1) that the defendant intentionally participated (2) in a scheme to defraud (3) the plaintiff of money or property (4) by means of material misrepresentations, (5) using the mails or wires, (6) and that the plaintiff relied on a misrepresentation made in furtherance of the fraudulent scheme, (7) that such misrepresentation would have been relied upon by a reasonable person, (8) that the plaintiff suffered injury as a result of such reliance, and (9) that the plaintiff incurred a specifiable amount of damages.

The elements of the predicate acts of mail and wire fraud are: “(1) the existence of a scheme to defraud; (2) the participation by the defendant in the particular scheme with the specific intent to defraud; and (3) the use of the United States mail or of wire communications in furtherance of the fraudulent scheme.” United States v. Syme, 276 F.3d 131, 142 n.3 (3d Cir. 2002).

Causation

To have standing under RICO, (1) a plaintiff’s “business or property” must have been “injured” (2) “by reason of” the defendant’s RICO violation. 18 U.S.C. The scheme “need not be fraudulent on its § 1964(c); Holmes v. Sec. Investor Prot. face but must involve some sort of fraud- Corp., 503 U.S. 258, 268, 112 S. Ct. 1311, ulent misrepresentations or omissions 117 L. Ed. 2d 532 (1992). reasonably calculated to deceive persons of ordinary prudence and comprehen- The Supreme Court has interpreted RIsion.” United States v. Pearlstein, 576 F.2d CO’s “by reason of” requirement to mean 531, 535 (3d Cir. 1978) (citation omitted). that the defendant’s RICO violation must Proof of specific intent is required, Id. at be the proximate cause of the plaintiff’s 537, which “may be found from a material injury. Anza v. Ideal Steel Supply Corp., 547 misstatement of fact made with reckless U.S. 451, 126 S. Ct. 1991, 1996, 164 L. Ed. disregard for the truth.” Hannigan, 27 F.3d 2d 720 (2006); Holmes, 503 U.S. at 268. To at 892 n.1. meet this proximate-cause requirement, the plaintiff must allege “some direct relation between the injury asserted and the injurious conduct alleged.” Holmes, 503 U.S. at 268.

The best way to defend against the first element of a civil RICO claim is to argue the professional had no specific intent to defraud.

The federal mail fraud statute reaches only the use of the mails when that mailing is part of the execution of a fraud. Schmuck v. United States, 489 U.S. 705, 710, 103 L. Ed. 2d 734, 109 S. Ct. 1443 (1989) (citing Kann v. United States, 323 U.S. 88, 95, 89 Sikes v. Teleline, Inc., 281 F.3d 1350, 1360- L. Ed. 88, 65 S. Ct. 148 (1944)). However, 61 (11th Cir. 2002) (footnotes omitted). the use of the mails need not be an essential element of the scheme. Id. (citing Pattern of Racketeering Activity Pereira v. United States, 347 U.S. 1, 8, 98 L. A “pattern of racketeering activity” is es- Ed. 435, 74 S. Ct. 358 (1954)). It is sufficient tablished with proof of the commission if the mailings are “‘incident to an essenof at least two acts of racketeering activity tial part of the scheme’ or ‘a step in [the] (known as predicate acts) within a 10-year plot.’“ 489 U.S. at 710-11 (quoting Badders period. 18 U.S.C. § 1961(5). “Racketeering v. United States, 240 U.S. 391, 394, 60 L. activity” is defined in a veritable laundry Ed. 706, 36 S. Ct. 367 (1916)). list of various state and federal offenses, 18 U.S.C. § 1961(1). Perhaps the two that The best way to defend against the first are most commonly used in claims against element of a civil RICO claim is to argue professionals are the mail fraud and wire the professional had no specific intent to fraud statutes, 18 U.S.C. §§ 1341 and 1343. defraud. For instance, if the professional

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was providing services to clients without knowing that the clients allegedly were defrauding others, he will have a strong initial defense available to him.

The issue becomes whether, in a RICO action predicated on a mail or wire fraud violation, a defendant’s alleged RICO violation and the plaintiff’s injuries can be directly related if the plaintiff did not rely to his detriment on the violation. In other words, one of the components of proximate cause is reliance; if a plaintiff did not rely on the defendant’s misrepresentation, then the misrepresentation cannot be the proximate cause of the plaintiff’s injuries.

Whether reliance is necessary to establish proximate cause continues to be unsettled law. The majority view stems from the Supreme Court’s decision in Holmes that a RICO plaintiff must show that his injury was proximately caused by the defendant’s misrepresentations. The thinking is, as a matter of simple logic, if a plaintiff did not rely on the defendant’s misrepresentations, his injury could not have been proximately caused by them. See Chisolm v. TranSouth Fin. Corp., 95 F.3d 331, 337 (4th Cir. 1996).

The Second, Fourth, Fifth, Sixth, Eighth, and Eleventh circuits have explicitly held that, consistent with the Supreme Court’s direction in Holmes that a civil RICO plaintiff alleging mail or wire fraud predicates must show that his injuries were proximately caused by the defendant’s scheme to defraud, the plaintiff must show that he

detrimentally relied on the defendant’s misrepresentations. See Bank of China v.

NBM L.L.C., 359 F.3d 171, 176 (2d Cir. 2004) (“[W]here mail fraud is the predicate act for a civil RICO claim, the proximate-cause element articulated in Holmes requires the plaintiff to show ‘reasonable reliance.’“), cert. dismissed, 546 U.S. 1026, 126 S. Ct. 675, 163 L. Ed. 2d 545 (2005).

The professional can be further defended in civil RICO claims by demonstrating that the plaintiff did not detrimentally rely upon the conduct at issue. This is particularly true if the plaintiff was not even aware of the alleged misrepresentations at the time they were being made.

Participation in the Enterprise In order to “participate, directly or indirectly, in the conduct of such enterprise’s affairs,” one must have some part in directing those affairs. Of course, the word “participate” makes clear that RICO liability is

not limited to those with primary responsibility for the enterprise’s affairs, just as the phrase “directly or indirectly” makes clear that RICO liability is not limited to those with a formal position in the enterprise, but some part in directing the enterprise’s affairs is required. The “operation or management” test expresses this requirement in a formulation that is easy to apply, and it is generally difficult to prove a lawyer or accountant, for instance, was operating or managing an enterprise with his or her clients as co-defendants. Often, the professional is added in these disputes between others, and does not truly belong there.

CONCLUSION The factual circumstances under which consumer-protection and RICO claims are asserted can often be very messy.

Even so, it has been our experience in the jurisdictions where we practice, and within the context of the cases we have defended, that such claims are generally unlikely to succeed and can be successfully defended. Every effort should be made to get these claims, at a minimum, dismissed at the summary-judgment stage (or sooner) so that the enhanced potential damages are not lingering, and so that the plaintiffs lose some leverage in potential settlement discussions involving any remaining claims. 

Practical Advice Civil RICO claims are difficult for a plaintiff to prove, but if not properly defended, they can have very serious consequences. They need to be carefully scrutinized, and aggressive discovery should be conducted.

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November 2018 | 11

SPOTLIGHT

The

Paradigm

Managing Corporate D&O Liability — Part II RECENT/COMING LEGISLATION In reaction to the spate of revelations of sexual harassment by senior corporate officers and directors over many years, a variety of legislation has been proposed or passed with the objective of making it more difficult to sweep such conduct under the rug, and conceal it. This has taken place on both the state and federal level. For example, on December 22, 2017, Congress passed Peter J. Biging, Heather M. Zimmer, and Todd D. Kremin the Tax Cuts and Jobs Act, which includes an amendment that This article originally appeared in the American Bar Association focuses exclusively on a company’s sexual harassment claims. 26 Tort Trial and Insurance Practice Section Committee on Profession- U.S.C. § 162(q), entitled “Payments related to sexual harassment and sexual abuse,” provides that: al Liability Insurance Spring 2018 newsletter.

Last issue, in Part I of this article, we explored the dawn of the #MeToo movement, the rise in sexual harassment allegations, and a number of claims that should put every corporate leader on notice that these types of claims, and how they are handled, can pose such risks today, and in a very substantial way.

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CLICK HERE to read Part 1 in our August 2018 issue.

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No deduction shall be allowed under this chapter for — 1. any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement, or 2. attorney’s fees related to such a settlement or payment.

This amendment could theoretically have far-reaching financial implications for companies going forward, as most settlements for sexual harassment claims are accompanied by a non-disclosure agreement. Yet, recent state legislation on the use of non-disclosure agreements may actually curb the impact that section 162 has on a company. As of April 5, 2018, the New York Legislature passed a bill that prohibits employers from including a non-disclosure agreement in any settlement of a sexual harass-

ment claim unless the complainant is the party to request it.1 In addition, this legislation will prohibit employers from requiring employees to contractually agree to arbitrate sexual harassment claims.2 New York Governor Andrew Cuomo signed the legislation into law on April 12, 2018.3 New Jersey and California are also contemplating similar legislation regarding non-disclosure agreements.4

ployees, standard EPLI policies may not extend to claims brought by third parties.7 Most D&O and EPLI policies also exclude coverage for claims of bodily injury, which means that an insurer will not cover claims for any type of touching, rape, assault, or battery. Additionally, both EPLI and D&O policies may have various exclusions, including an exclusion for criminal acts, fraud and dishonesty. However, emotional distress and anguish associated with any Moreover, California lawmakers have also bodily injury may be covered under an proposed legislation to extend the statEPLI policy, and stand-alone policies such ute of limitations for employment related as Sexual Abuse & Molestation policies are sexual harassment claims under Califoravailable to protect management, emnia’s Fair Employment and Housing Act ployees and the entity against allegations from one year from the date upon which of abuse, molestation or mistreatment of the unlawful practice occurred to three a sexual nature. Further, the exclusion for years.5 Several other states are considering fraud and dishonesty typically requires fisimilar legislation to extend the statute of nal adjudication to apply. limitations for plaintiffs to file a civil suit or for district attorneys to prosecute related It also should be noted that D&O insurance cases, including Massachusetts, Missouri, is intended to cover claims for the “wrongNew York, Washington, Wisconsin, Michi- ful acts” of a company’s directors and offigan, and Vermont.6 cers, but only if the director or officer was While we have yet to see what financial acting within the course and scope of his/ impact any of this legislation will have on her employment when committing the act. companies, it is sure to put a company Accordingly, a gap in coverage may occur if more at risk and change the way it ad- the director/officer committed the wrong8 dresses allegations, as negotiated resolu- ful act outside the scope of employment. tion of sexual harassment claims will be D&O policies also typically contain an “inmore and more difficult going forward to sured vs. insured” exclusion, which may keep secret, and the time frames within operate to preclude coverage for claims which such claims can be brought is likely made by employees deemed an Insured Person under the policy terms against an to be broadly expanded. executive insured under the policy and/ MANAGING/MITIGATING THE RISK or the company. And while damage to D&O, EPLI AND RELATED COVERAGE the company’s reputation from the disTraditionally, companies have sought to closure of claims of sexual harassment by manage the risks presented by the poten- senior corporate management or a cultial for sexual harassment by officers and ture which either encourages or ignores directors principally through the purchase rampant sexually harassing behavior may of Employment Practices Liability Insur- pose perhaps the biggest financial risk to ance (“EPLI”) and D&O policies, which in- the company, D&O policies may not afford clude EPL coverage. As EPLI coverage is coverage for the cost of retaining a public intended to cover claims brought by em- relations firm to respond to the issue.9

Another issue to be aware of is that D&O and EPLI policies provide claims-made coverage, and thus only provide coverage for claims made against a policyholder during a specified period. Claims-made policies generally require that a policyholder timely report any claim made to the insurer, which may be a period of thirty days. Accordingly, gaps in coverage may arise when a company fails to promptly report a sexual harassment claim to an insurer or assume that a previous or future claim is covered by its policy.

Gaps in coverage can also arise through a prior acts or prior litigation exclusion, which excludes coverage for claims involving facts or occurrences that were either the subject of prior litigation or commenced before the start of coverage.10 Under this exclusion, an insurer can deny coverage where there are common facts between the prior claim and the current claim. If, for example, a company receives a books and records demand which includes certain allegations of potential wrongdoing, an insurer could potentially deem that demand a prior or pending litigation for purposes of the exclusion.

Moreover, companies should be aware of the aggregate limit of liability and per claim deductibles in their policy’s terms.

Specifically, claims that arise out of the same or related events are treated as a single claim starting from the earliest date the claim is reported.11 As such, separate lawsuits, related class action complaints, and suits filed by multiple plaintiffs may be deemed to create a single claim subject to a single maximum limit of liability and only one claims made policy.12 This will have an impact in the sexual harassment context when plaintiffs file various complaints stemming from the same wrongs, same pattern of sexual harassment, and (continued on next page)

1

N.Y. Senate Bill S7507C, Subpart D, S5-336 (2018) (“Nondisclosure Agreements. Notwithstanding any other law to 29 the contrary, no employer, its officers or employees shall have the 30 authority to include or agree to include in any settlement, agreement or 31 other resolution of any claim, the factual foundation for which involves 32 sexual harassment, any term or condition that would prevent the disclosure of the underlying facts and circumstances to the claim or action 34 unless the condition of confidentiality is the complainant’s preference.”).

2 N.Y. Senate Bill S7507C, Subpart B, S7515 (2018).

3 See N.Y. State Senate, Senate Bill S7505C, https://www.nysenate.gov/legislation/bills/2017/s7507 (last visited May 24, 2018) 4 See Daniel Wiessner, Sexual misconduct outcry makes U.S. lawyers rethink confidentiality, Reuters (Dec. 19, 2017), https://www.reuters.com/article/us-usa-misconduct-agreements/sexual-misconduct-outcry-makes-u-s-lawyers-rethink-confidentiality-idUSKBN1ED1DM. 5 Assembly Bill No. 1870, revised (CA Apr. 19, 2018), https://leginfo.legislature.ca.gov/faces/billTextClient.xhtml?bill_id=201720180AB1870.

6 Rebecca Beitsch, #MeToo Movement Has Lawmakers Talking About Consent, Huffington Post (Jan. 24, 2018), https://www.huffingtonpost.com/entry/metoo-movement-has-lawmakers-talkingabout-consent_us_5a6758dfe4b06bd14be5067f.

7 This said, many modern forms have incorporated insuring agreements or optional coverage for discrimination and harassment claims brought by third parties, such as customers, client and vendors.

8 For a more thorough analysis of D&O with EPL insurance coverage, see Kevin LaCroix, Guest Post: Sexual Misconduct Claims: How Charitable is Your D&O Policy?, The D&O Diary (Apr. 19, 2018), https://www.dandodiary.com/2018/04/articles/director-and-officer-liability/guest-post-sexual-misconduct-claims-charitable-policy/.

9 Some D&O policies offer crisis fund type coverage; however, whether such coverage may apply in any given situation will depend on the applicable facts and the policy’s wording.

10 See David E. Bordon & Ellen B. Van Vechten, 4 Law and Prac. of Ins. Coverage Litig. § 47:22 (2017).

11 See David E. Bordon & Ellen B. Van Vechten, 4 Law and Prac. of Ins. Coverage Litig. §§ 47:13, 74:26 (2017).

12 Id.

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the same breaches of fiduciary duty as evidenced by the various suits filed against Wynn and the directors and officers of Wynn Resorts.

Insurers can also refuse coverage when a policyholder previously made misrepresentations on their policy applications.

For instance, in Zion Christian Church v.

Brotherhood Mut. Ins. Co., the 6th Circuit found that an insurer could reject coverage where the insured made several misrepresentations on its application by concealing past sexual conduct.13 Similarly, a federal judge rescinded two D&O policies because the company failed to disclose past sexual harassment claims against its CEO on its policy applications.14 When filing applications, companies must confirm the accuracy of all statements made in applications or risk a lapse in coverage.15 SEC REPORTING DUTIES As the Weinstein and Wynn cases evidence, it should now be considered to be an important part of risk management in this regard to be conscious of a possible need to report sexual harassment claims on the company’s public filings. As it is now abundantly clear that such claims can have a material impact on the firm’s business and stock price, it will no longer be valid to assume that settlements of such claims have fully addressed the issues raised thereby.

EMPLOYMENT POLICIES AND ADDRESSING SEXUAL HARASSMENT CLAIMS Lastly, there needs to be a renewed focus on monitoring and enforcing the company’s sexual-harassment policies. While insurance may cover the financial costs of a suit and any resulting settlement, and there is naturally a presumption that the individuals you entrust with the management and operations of your business are going to generally comport themselves appropriately, the revelations emerging as a result of the #MeToo movement should cause boards to be more wary of things that could be quietly lurking beneath the surface. “Assuming the best” is not a viable risk management policy, and certainly not in the times we now live in. And assuming

that just because the company has written policies in place, employees are fully aware of their rights and feel safe and comfortable reporting sexual harassment is a dangerous assumption to make.

CONCLUSION Even in the current climate, successful securities fraud actions based on alleged misrepresentations in the form of aspirational statements by a corporation regarding a refusal as a matter of policy to tolerate harassment or of a practice of consistently promoting a culture committed to honest and ethical conduct will still be unlikely.

But if a complaint sets forth specific allegations of abhorrent ongoing conduct by senior management and/or a widespread toxic culture, there is a much greater likelihood that such actions will survive a

There needs to be a renewed focus on monitoring and enforcing the company’s sexualharassment policies.

some very ugly things crawling around underneath. As such, it can reasonably be anticipated that claims of this sort are more likely to grow in the short term, particularly in the realm of the shareholder derivative suit against the small to mid-size privately held corporation dominated by an individual around whose entrepreneurial aptitude the company has been built.

Corporate awareness of the risk presented by this behavior and the implementation of systemic processes to meet the risk is critical, so that the lessons currently being taught by the #MeToo movement quickly become lessons learned.

In order to address this developing risk, professors Daniel Hemel and Dorothy Lund offer a useful list of suggestions for boards to consider going forward in an effort to both avoid the risk altogether, and attempt to manage it as claims may arise, including: • Taking stock of their companies’ past responses to sexual harassment claims, and in so doing identify repeat offenders, so they can be weeded out.16 • Reviewing their companies’ procedures for handling complaints, and taking steps to ensure that employees are both fully aware of and feel comfortable reporting misconduct.17

motion to dismiss. Indeed, allegations of • Ensuring that policies providing for “meaningful consequences” for harassknowledge of ongoing and continuing sexers are in place (including empowering ual harassment and other sexual misconmanagers to impose a range of sancduct, potentially exposing the corporation tions ranging from reprimands to bonus to significant liability, as well as having the reductions to termination for repeat ofcapacity to do substantial damage to the fenders).18 corporate brand, coupled with efforts to insulate particular officers and directors • When confronted with allegations of from the consequences of such conduct sexual harassment engaged in by corpoand conceal same through the entry into rate officers or widespread harassment confidential settlements, are far more throughout the company, hiring outside likely to provide the basis for a successful counsel to conduct a thorough investisecurities fraud or shareholder derivative gation of the claims.19 action. And while one might think these types of circumstances would be unlikely • Approving the use of corporate funds to pay liability and litigation related exto be found except in very rare instances, penses only in those instances where an the fact of the matter is that the #MeToo internal investigation has been undermovement has lifted what was previously taken and it has been concluded that a very large and protective boulder, and those claims are unfounded.20 in the process given the world a peak at

13 See Zion Christian Church v. Brotherhood Mut. Ins. Co., 126 Fed. Appx. 235 (6th Cir. 2005) 14 See U.S. Specialty Insurance Co. v. Bridge Capital Corp. et al., No. SACV 06-85, 2007 WL 1138863 (C.D.Cal. Apr. 11, 2007).

15 A useful article summarizing some of the issues to consider in regard to D&O insurance for sexual misconduct can be found at Kevin LaCroix, Guest Post: Sexual Misconduct Claims: How Charitable is Your D&O Policy, The D&O Diary (Apr. 19, 2018), www.dandodiary.com/2018/04/articles/director-and-officer-liability/guest-post-sexual-misconduct-claims-charitable-policy/.

16 See Hemel & Lund, supra note 41 at 57.

17 Id. at 58.

18 Id. 19 Id. at 59.

20 Id.

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• Accepting that even in cases where the target of the allegations is a CEO who is associated with the company’s brand, there is misconduct that rises to the level of a fireable offense, and that “[t]he damage to a firm’s value from losing an iconic CEO may be far less than the reputational consequences of a high-profile sexual harassment scandal.”21

potentially arise in regards to insurance • Making sure that knowledge and awareclaims, so they are guided accordingly. ness of claims has been fully vetted at the These include: time of policy application.

• Analyzing the company’s D&O and EPLI insurance to make sure it provides the levels of coverage necessary to meet the risk presented. This includes careful consideration of per claim deductibles and aggregate limits.

• Considering the purchase of coverage for retention of a public relations firm to handle crisis management.

As Ben Franklin famously stated, “by failing to prepare, you are preparing to fail.” For corporate boards, the #MeToo movement • Considering whether statements in their is a call to action, and none too soon.  SEC filings might be misleading if sexual • Taking stock of the complaints that 22 have been resolved via settlement, and misconduct claims emerge. whether the continued employment of Additionally, boards need to give careparticular repeat offender directors and ful consideration to the insurance covofficers may, because of the new dynamerages in place, what is and is not likely ic, present much greater exposure to fito be covered, and the issues that may nancial risk than previously anticipated.

21 Id. at 60.

22 Id.

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CASE NOTES

How to Legally Dispel a Stereotype Lisa Balducci v. Brian M. Cige, Docket No. A-3068-16T2, (N.J. App. Div. Aug. 30, 2018) Andrew P. Carroll The Three Stooges fictional law firm “Dewey, Cheatem & Howe” is just one example of the stereotype that attorneys value money over clients.

Under a contingency-fee agreement, however, an attorney takes a significant risk of nonpayment. In a recent New Jersey appellate decision, the court held that some risk may be shifted to the client through an hourly arrangement, but this is valid only if both the implications and alternatives have been thoroughly explained.

In Balducci v. Cige, the plaintiff signed a retainer agreement that provided for attorneys’ fees equaling the greater of an hourly rate, a 37.5% contingency fee, or any statutory fees obtained at trial.

As is often the case, the dispute first arose because of what the plaintiff saw as ineffective counsel and overbilling. The plaintiff testified that her attorney was off at a chess tournament while she prepared herself for her deposition, that he appeared unprepared for the depositions he took, and that he failed to explain the exorbitant administrative costs charged to her. After the client terminated the relationship and the attorney sent her a bill for approximately $250,000, she filed a declaratory judgment action seeking the nullification of their fee agreement.

The trial court ruled in the plaintiff’s favor and the Appellate Division affirmed, providing additional guidance to plaintiffs’ attorneys handling matters on an hourly basis. The court began by finding that the agreement itself was “ambiguous if not misleading,” noting that the existence of a statutory fee-shifting mechanism for the discrimination claims at issue complicates application of the agreement’s language. The court then discussed what it called “liberal billing practices” and the “egregious” practice of charging $1 for each incoming and outgoing email, in addition to the attor-

16 | PLM

ney’s hourly rate, as problematic but not dispositive. It was within this context of troublesome facts that the court found the attorney failed to adequately explain the fee agreement to his client. Specifically, the Appellate Division held that any attorney handling a discrimination claim on an hourly basis must not only explain how it shifts all risks of nonpayment to the client but that there are also competent counsel who would take the matter on a contingency basis. The court concluded that failing to explain how costs could exceed recovery, and the alternative forms of representation available, violated Rule of Professional Conduct 1.4(c), governing adequate communications with a client. The retainer agreement was therefore rendered null and void, leaving the attorney with only a quantum meruit claim to recover for services performed.

While the Appellate Division’s holding is couched in language specific to discrimination claims, its logic applies to any non-contingency plaintiffs’ work and should be treated as such. Attorneys take a significant risk by taking cases on a contingency basis, and the Appellate Division in Balducci does not foreclose the ability to shift some of that risk through an hourly arrangement. However, the court makes clear that an attorney must explain in full the implications – and alternatives – to such an agreement. Any plaintiffs’ attorney looking to use creative fee arrangements should therefore carefully craft the agreement and ensure that these new prescriptions for disclosure have been met prior to any engagement.

CASE NOTES

Computer-Crime Coverage: Are Changes on the Horizon?

American Tooling Center, Inc. v. Travelers Casualty & Surety Co. of America, No. 16-12108, 2017 WL 3263356 (E.D. Mich. Aug. 1, 2017), rev’d No. 17-2014 (6th Cir. July 13, 2018) Joseph A. Oliva In American Tooling Center, Inc. v. Travelers Casualty & Surety Co. of America, No. 16-12108, 2017 WL 3263356 (E.D. Mich. Aug. 1, 2017), rev’d No. 17-2014 (6th Cir. July 13, 2018) a coverage dispute arose when American Tooling Center, Inc. (ATC), authorized payments to a bank account it believed to be that of one of its vendors. ATC, a manufacturer, outsourced some of its orders.

ATC paid its international vendors via wire. Vendors submitted invoices via email for payment, and each month ATC would verify which invoices were to be paid; one employee would enter the wire instructions on a computer and another employee would approve the transaction. A fraudster, using an email address virtually identical to an international vendor’s email address, instructed ATC to wire payment to an account not controlled by the vendor. ATC did not have a policy to verify the changed information. By the time the fraudulent scheme was discovered, the funds had already been transmitted. ATC sought coverage under a computer crime policy for loss “directly caused by computer fraud.” The carrier denied the claim.

IMPACT: The language of computer fraud-insuring clauses has become a hot topic in the fidelity-insurance world. While many courts have found that the language covers losses where an actual “hacking” has occurred into an insured’s computer system, other cases, like this one, appear to be challenging the intent of the policy language in computer-crime coverage. Interestingly, the court in this case never addressed the fact that ATC did not have a policy in place to verify information, nor did the court address the technical side of entering data on a computer. These issues will likely be addressed in future cases.

The District Court found in favor of the carrier, finding the loss was not directly caused by the loss of a computer because the real cause was ATC’s failure to independently verify the bank account change with the vendor. Therefore, due to the intervening events between the receipt of the fraudulent emails and the authorized transfer of funds, it could not be said that the loss was directly caused by a computer.

The Sixth Circuit reversed and found that ATC’s loss was a direct or immediate result of the fraudulent email received and ATC’s reliance on that fraudulent email in transferring the funds.

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November 2018 | 17

CASE NOTES

Real Experts Needed as WebsiteAccessibility Actions Gain Momentum Gomez v. Gen. Nutrition Corp., 323 F Supp 3d 1368 (S.D. Fla. 2018) Joanne J. Romero

The court also held that based on the plaintiff’s expert’s testimony that accessibility issues remained that could prevent product seIn this website-accessibility action brought under lection and purchases by users, GNC was discriminating against Title III of the Americans with Disabilities Act (ADA), the plaintiff in violation of the ADA. Gomez, a legally blind online shopper, alleged that GNC’s website was inaccessible because his IMPACT: This decision serves to highlight the growing conscreen reader could not properly read the websensus among courts in all jurisdictions that websites are site’s content. GNC claimed it had remediated its website; its explaces of public accommodation and the need for busipert testified that automated accessibility tests he used returned nesses facing web-accessibility lawsuits to retain qualified zero errors and no known problems. experts to evaluate website accessibility and to provide remediation guidance. It is a common mistake for businesses Gomez filed a motion for summary judgment and a motion to to rely on existing web designers or other web professional exclude defendant’s expert testimony. The court granted both who have no specific website-accessibility training and who, motions, in part. In granting partial summary judgment, the court in turn, rely solely on automated software that, standing held that: alone, can be insufficient to identify all the accessibility vio• Gomez had standing to seek injunctive relief even as a “tester” lations under current WCAG 2.0 or 2.1 standards. because “by facing barriers to access the Website, Gomez suffered a concrete injury, [a]nd if not addressed, he could suffer that same injury in the future.”

• The website constituted a place of public accommodation because it facilitated use of the physical stores by providing the ability to purchase products from the physical store through the website, learn about sales, and find nearby stores.

In granting, in part, the plaintiff’s motion to exclude GNC’s expert’s testimony, the court found that GNC’s expert was not qualified to opine on website accessibility because: (1) he lacked specialized knowledge, professional training, or experience on website accessibility; (2) did not know the success criteria of the automated software he had used; and (3) did not normally run these tests himself.

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