American Apparel Inc. disclosed recently that The Securities and Exchange Commission has launched a formal investigation into issues raised during its Board evaluation of matters relating to its ousted CEO Dov Charney. It said that the Company intends to cooperate fully with the SEC. This investigation has arisen in the context of civil litigation against American Apparel, actual and threatened, brought following the emergence of details concerning Charney’s sexual harassment of American Apparel employees, and the American Apparel Board’s alleged lack of oversight of the Company.

It is not uncommon that companies face battles drawn simultaneously on both civil and regulatory fields: allegations within civil proceedings (including class actions) can lead to regulatory proceedings and vice versa. Often proceedings overlap, forcing companies to focus their attention and resources on separate but inter-related matters, each fraught with unique but potentially serious exposure, including significant reputational risk.

There are many Canadian examples of companies forced to defend civil and regulatory proceedings. Some notable instances include: BMO Nesbitt Burns, who faced class proceedings and an OSC proceeding in relation to its distribution of securities of FMF Capital Group during an IPO; Nortel Networks Corp., who dealt with concurrent class proceedings and OSC proceedings in relation to alleged misrepresentations it made about its financial performance to investors; and Sino-Forest Corporation, who is currently fighting a class proceeding and an OSC proceeding in light of its alleged false and misleading statements in its public filings.

The American Apparel Example

In July 2014, a shareholder derivative suit was commenced in California against American Apparel Inc., its former CEO, Charney and its directors. The suit alleges that Charney’s sexual harassment of American Apparel employees, financial mismanagement, and the Board’s lack of oversight caused damage to the Company’s financial status. Charney was removed as CEO in December after the Company undertook an internal investigation into his alleged misconduct. In December 2014, Charney brought a motion to dismiss the civil claim, claiming the shareholders’ derivative action was not in the best interests of American Apparel, the shareholders had no standing to bring their claim, Carney’s conduct towards his employees was known prior to the plaintiffs purchasing Company stock, and that the plaintiffs were after their own financial benefit. Counsel for the plaintiffs sought to admit interviews and corporate filings disclosing the SEC investigation in support of their position on the motion to dismiss. The Board learned in February 2015 that the SEC had issued a formal order of investigation into the Company’s review of Charney, and took the position that the plaintiffs failed to explain how the SEC investigation supports the plaintiffs’ claims in the civil action. On April 13, 2015, U.S. District Judge Michael Fitzgerald allowed the defendants’ motion to dismiss the case because the plaintiffs failed to provide the date they purchased Company stock. Judge Fitzgerald also granted the plaintiffs leave to amend their claim.

The Impact of the OSC’s “No-Contest” Settlement Regime on Parallel Proceedings

The OSC’s March 2014 introduction of “no-contest” settlements was in part a recognition of the difficulty facing regulators and civil litigators simultaneously. From the point of view of an accused wrongdoer, “no-contest” settlements may allow companies to quickly resolve regulatory proceedings without admitting to facts or liability that may be detrimental to their defences in concurrent class actions and other civil proceedings. For regulators, the availability of “no-contest” settlements can help facilitate the speedy resolution of proceedings, given the greater willingness of respondents to settle without concern that any admissions they may make will lead to increased exposure in civil proceedings. See our prior blog post on this topic: OSC Approves First No-Contest Settlement – Ernst & Young LLP to Pay $8 Million. We have also addressed this issue on Osler’s Canadian Class Action Defence Blog: Increased Risk of Securities Class Actions with Regulatory Proceedings.

The plight of American Apparel is another reminder that when faced with a civil claim, companies and boards must always have an eye on regulatory proceedings that may be on the horizon (or vice versa). Companies should ensure that they are prepared to defend multiple proceedings holistically in a coordinated fashion, and should consider pre-emptively developing internal procedures with legal counsel and other experts to outline how the risks posed by litigating on multiple fronts can be managed.