In the wake of the implementation of the Sarbanes-Oxley Act of 2002, and the increased oversight of corporations pursuant to the Act, corporate counsel are justifiably concerned over how to prevent their companies from being targeted for the next regulatory investigation by either state or federal authorities. Counsel are taking a more active role in policing company compliance. At the same time, none other than business theorist Peter Drucker concluded recently that these reporting costs (of which he included regulatory compliance) are quickly becoming more significant than direct labor costs for corporations. Expenses associated with compliance with Sarbanes-Oxley are expected to further increase companies' costs by requiring public companies to routinely conduct audits of their financial control systems and recognize any "material weaknesses" in those systems.
This presents a dilemma for corporate counsel. On the one hand, by cracking down and imposing strict constraints on any seemingly questionable activity, business units may perceive corporate counsel as stifling productivity in an already regulated environment. Conversely, counsel may choose to address thorny regulatory compliance issues as they are "red flagged" by the government. Adoption of a "wait and react" approach inevitably leads to a company incurring significant legal fees with unknown outcomes. In the end, neither extreme is a preferred course of action. How can in-house counsel advise their company to both maximize revenue opportunities while reducing or avoiding regulatory risk? The answer is to work cooperatively with the business units to identify problems early and to implement modifications quickly. In short: Expend resources early on a problem or pay exponentially to clean them up later.
Counsel may ask: "Why should I spend scarce resources - and increase costs - now to detect potential regulatory violations before others outside the corporation discover the problem?" By taking proactive steps toward containing regulatory problems, corporate counsel makes an investment in future cost-savings and preservation of corporate goodwill. Often, the business units could achieve their objectives with only slight changes, if counsel is consulted early enough in the process. These prophylactic measures are especially pertinent for companies operating in regulated industries. All corporate counsel can therefore benefit from understanding the experiences of other companies in their dealings before regulatory agencies and recognizing trends associated with regulatory violations. Using the example of the dynamic industry of communications and its overseer, the Federal Communications Commission ("FCC"), as a model, the following are three thoughts to consider when identifying and addressing regulatory problems in your company.
Understand The ImplicationsOf Regulatory Non-Compliance
Corporate counsel should communicate clearly to business units the financial implications of regulatory non-compliance in all operational aspects of their business. Notably, high profile activities typically are not those that normally lead to regulatory violations. Rather, it is seemingly routine corporate functions and the failure to either monitor or manage those functions that often lead to significant payouts to government agencies.
As an illustrative example, consider the recent experience of AT&T. In December of 2004, AT&T executed a consent decree with the FCC for $500,000 related to violations for the unauthorized placement of a $3.95 monthly fee on some consumers' telephone bills for a period of about three months. AT&T did not intend to place the charge on each customer's bill. Rather, the incident stemmed from "coding and systems processing issues," i.e., a mistake with AT&T's billing system. The cost of this simple mistake far exceeded the refunds AT&T made to customers or administrative costs associated with restatement of revenues. AT&T's billing mistake cost it an additional $500,000 in regulatory costs.
The risks of non-compliance are not limited to monetary penalties. Companies that either do business with the federal government or expect benefits in the form of explicit approvals are subject to the requirements of the Debt Collection Improvement Act of 1996 ("DCIA"). The DCIA provides, above all else, that the federal government will receive payment for all debts owed to the government and may use a denial of benefits as a collection tool. For example, the FCC's "Red Light Rule" operates to both identify every company that is delinquent in its regulatory payments to the agency and to halt any review of a delinquent company's applications for license transfers, assignments, or bid requests for valuable communications spectrum. In short, the agency can withhold approval of your company's transaction. For corporate counsel this means that either it (or outside counsel) must perform the appropriate regulatory due diligence before pursuing a merger, acquisition, or asset sale. Corporate counsel does not want a critical merger to be delayed - and for the company to incur major costs - due to a previously undetected failure to pay a regulatory fee.
Recognize Regulatory "Trigger" Points
Corporate counsel should understand further which particular corporate functions could serve as enforcement "triggers" for regulatory agencies. Generally, government agencies are concerned with a corporation's management of corporate functions which have an impact on the public at large. It is therefore critical that corporate counsel monitor all aspects of the customer's relationship with the company.
One area to pay close attention to is customer billing. As discussed above, billing is not just a finance department issue; billing errors represent legal costs. The bottom line for corporate counsel is to establish appropriate internal systems to consider whether routine business functions have the potential to incur regulatory costs.
In addition, counsel should pay close attention to its customer care operations. Customer care often provides the early warning system for compliance problems. Customers concerned with a possible billing error, a policy that was not adequately explained or a product that did not perform as expected will first call the company's customer care center. Only customers who remain dissatisfied after this initial encounter are likely to file complaints with enforcement authorities or consumer advocacy groups. Put another way, we have yet to see the regulatory complaint that did not also include a customer care complaint.
Early Communication With Government Is Better Communication
If corporate counsel does identify a potential regulatory problem, the next course of action is to determine whether and when to reveal it to a government agency. Experience teaches that regulatory agencies view early voluntary disclosure favorably if the company is forthcoming and deferential to the agency's agenda. Consider the comparative examples of Enron Corporation and International Business Machines ("IBM").
In 1998 and 2002, in the wake of a 1997 merger transaction between Enron and Portland General Corporation, Enron determined that it might have improperly transferred control of multiple FCC wireless licenses. On its own initiative, Enron filed two sets of applications for retroactive approval of the 1997 transaction. Although the agency granted the post-transaction applications, the agency believed it necessary to enter into a consent decree for unauthorized pro forma transfers of control of the wireless stations. In 2002, the FCC accepted a voluntary contribution of $7,500 from Enron, taking into account Enron's voluntary approach and conduct before the agency and the company's willingness to implement a comprehensive compliance program.
By contrast, in 1999, the FCC issued a Notice of Apparent Liability for Forfeiture ("NAL") against IBM, finding the company apparently liable for conduct very similar to that of Enron. Subsequent to the issuance of the NAL, IBM approached the FCC and voluntarily disclosed evidence of additional license transfer violations. After further discussions, IBM agreed to make a total voluntary contribution to the U.S. Treasury of $70,000 to settle all remaining license violations.
The operative lesson for corporate counsel is that Enron voluntarily approached the FCC with evidence of violations before the FCC became aware of a problem. Although IBM also voluntarily disclosed evidence of additional potential violations to the agency, the disclosure came after the FCC's public announcement of IBM's apparent wrongdoing and its own commitment of resources to the investigation. Enron chose to spend corporate resources on establishment of a compliance program before approaching a government agency, thereby avoiding substantial penalties. Ironically, Enron, a company today associated with the depths of corporate malfeasance, benefited financially by approaching a federal agency early with evidence of minor violations and a solution to prevent them from occurring in the future.
As the above examples illustrate, the early identification of potential regulatory problems is not solely a legal and professional duty on the part of corporate counsel, but it also carries with it a direct impact on a company's profitability. Indeed, the costs of non-compliance can escalate quickly: The discovery of a problem by one regulatory entity carries with it the risk that another agency with overlapping or concurrent jurisdiction over your company's activities may initiate its own separate investigation.
Corporate counsel's discovery of a regulatory problem should serve as a wake-up call to conduct a vigorous internal investigation of the company's practices and establish early warning systems to prevent future problems. Counsel can accomplish this task either through regular and consistent monitoring of company activities or in conjunction with experienced outside counsel. The investment in regulatory compliance for your company today carries with it practical, financial benefits for your company by reducing a company's costs and increasing net revenues in the long term.
Steven A. Augustino is a Partner in the Washington, DC office of Kelley Drye & Warren LLP, where his practice focuses on technology and telecommunications matters. Darius B. Withers is a Senior Associate in the Washington, DC office of Kelley Drye. He focuses on regulatory and government affairs matters, primarily for clients in the telecommunications industry. They may be reached at (202) 955-9600.