Does a Company Have to Pay for the Defense of a Former Officer Who Was Criminally Charged (Twice) with Stealing the Company's Trade Secrets?

That’s the question presented by a recent lawsuit filed by Sergei Aleynikov, a computer programmer who was a Vice President at Goldman Sachs responsible for code relating to Goldman’s high frequency trading business (more on “HFT” here) before he left to work for a hedge fund – allegedly bringing Goldman’s “secret sauce” code with him.  We’ve observed before that contractual rights to indemnification can sometimes lead to head-scratching results, but, depending on the outcome, this case may take the cake.  Plus, it nicely illustrates key concepts about indemnification (our focus today) and advancement (our focus later this week).

Aleynikov was twice charged for allegedly stealing Goldman’s code.  The first time, he was indicted by federal prosecutors in New York.  That case went all the way to trial.  The jury convicted Aleynikov, and he was sentenced to more than eight years in prison.  Aleynikov appealed.  The U.S. Court of Appeals for the Second Circuit reversed his conviction on the ground that the federal statutes that he was charged under did not criminalize his taking of the code, which is “intangible” and was “not designed to enter or pass in commerce, or to make something that does.”

Briefly, Aleynikov was a free man, although he had racked up more than $2 million in legal fees, and had run out of money.  But, in August, less than six months after the Second Circuit’s reversal of his conviction, he was charged by the Manhattan district attorney for state crimes relating to his taking of the code and arrested.

In the lawsuit against Goldman that he filed last week, Aleynikov seeks a court order directing Goldman to reimburse him for the legal fees that he incurred defending against the federal case – in other words, indemnification.  He also seeks a court order directing Goldman to pay on a current basis the legal fees that he has incurred and will incur for the state case – in other words, advancement.

You may be surprised that any person – no matter how important  – would be entitled to have his legal expenses paid by his former company for (1) a criminal case, (2) after a jury convicted him for stealing valuable trade secrets from the company.    

Here’s some background.  Goldman, like many companies, is incorporated in Delaware.  Delaware law permits companies to provide broad indemnification rights in their bylaws for their directors and officers.  The theory behind the law is that, otherwise, companies will not be able to attract the best and brightest to their C-suites.  The best and brightest will work elsewhere, rather than risk having their personal financial resources drained in defending against a case relating to their work for the company.  Goldman seems to have embraced the theory.  Its bylaws provide for mandatory indemnification to the fullest extent permitted by law.  That is not unusual.

(By the way, there appear to be questions in Aleynikov’s case about whether the Goldman subsidiary that Aleynikov worked for was bound by the bylaws of the parent company, and whether Aleynikov was a director or officer covered by the bylaws’ indemnification provision.   The case may well end up turning on those questions.  We are putting them aside for now.  That's the nice thing about having a blog.  You can do that.)

Now, back to the issues presented by Aleynikov’s lawsuit. 

First, a person may be entitled to indemnification for a criminal case if he is successful on the merits of the case.  Aleynikov relies on Section 145(c) of the Delaware Code provisions on indemnification, which requires corporations to indemnify former directors or officers who have “been successful on the merits or otherwise in defense of any . . . proceeding referred to in subsections (a) and (b) of this section.”  Subsection (a) provides that corporations “have the power to indemnify any person who is a party to a proceeding,” including “criminal” proceedings “by reason of the fact that the person is or was a director [or] officer . . . of the corporation . . . .” 

So, just because the case was criminal in nature doesn’t mean that a company does not have to indemnify.  That leaves the question of whether getting a conviction overturned on appeal (even on what may seem like technical legal grounds) is “success on the merits.”  Aleynikov says that it is.  That also leaves the question of whether a person’s facing criminal charges for stealing from a company on his way out the door is a proceeding “by reason of the fact” that the person was an officer or director of the company.  Aleynikov says that it was because he only had access to the secret code that he allegedly stole by reason of the fact that he was an officer of Goldman. 

Aleynikov’s case against Goldman also raises the issue of whether the exclusion in subsection (a) frees Goldman from any obligation indemnify – specifically, the part of subsection (a) providing that corporations only have the power to indemnify a person if “the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person's conduct was unlawful.”

According to Aleynikov, the exclusion does not apply because it is not found in subsection (c) (the provision that he is relying on), and, even though subsection (c) incorporates part of subsection (a) by reference, it only incorporates the part describing the “proceeding” for which indemnification is required, not the rest of the subsection.  

We’ll be on the lookout for Goldman’s response.

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• Indemnification and Advancement
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