Sentencing A Corporation To Death - A Death Sentence For Self-Regulation?

Thursday, March 1, 2007 - 01:00

Editor: Why do you feel that the relationship between government and the business community needs to change?

Ide: The present Post-Sarbanes-Oxley era is a new day for corporations - with good progress in corporate self-governance, but also with misguided intrusions into governance by criminal prosecutors. Corporate governance is better. Directors who serve on boards are much more conscientious. More attention is being given to self-regulation. At the same time, we have seen the interests of shareholders not represented well by threats of criminal indictments against corporations (instead of individual officers) and demands for waiver of rights ( attorney-client privilege, right to defense costs for officers).

Right after the collapse of Enron and WorldCom, prosecutors felt that they had to blast down doors and use hard ball tactics because a few companies were viewed as being controlled by rogue individuals. Even if the tactics were ever justified, they are not necessary today, but the enforcement community is still utilizing them.

Policy needs to be set to restore the proper balance between self-regulation and regulation through prosecution. Concerning the overall public interest when corporations are alleged to have violated laws concerning financial improprieties, the general rule should be criminal actions against corporate individuals and civil actions such as derivative shareholder actions to assure proper corporate behavior. Allowing criminal prosecutions against corporations when only a few individuals within the corporation committed the fraud is like throwing the baby out with the bathwater. Shareholders, innocent employees and other stakeholders are damaged needlessly.

Editor: Why do you think that self-regulation will work?

Ide: The influence of Sarbanes-Oxley and the Federal Organizational Sentencing Guidelines together with more aggressive shareholder scrutiny has created a pervasive culture of effective self-regulation in the corporate community. Just as companies adopted zero defects as a goal in the face of Japanese competition, so today they compete to adopt compliance programs that aim at zero compliance failures - and the zero compliance defect goal comes from the very top, the board itself.

Corporate directors have learned the lesson that they too may face devastating personal consequences if there are compliance breakdowns. Their reputations may be sullied, and they may face personal financial liability and possible criminal proceedings. They are constantly being reminded of this - most recently, by Chancellor Chandler's February decision to permit shareholder derivative suits against directors to go forward in Delaware based on stock option backdating allegations.

Another important trend attesting to the ability of companies to undertake effective self-regulation is the enhanced status and role of the general counsel and of the lawyers who report to her. It has become a best practice for general counsel to meet in executive session with the board and the audit committee to assure independent legal oversight of management.

There still needs to be strengthening of compliance systems by getting more resources behind them. General counsel are at times guilty of not giving enough attention to the compliance function because, irrespective of the organization chart, the finger will point to the general counsel if there is an avoidable compliance failure

Given the business community's current commitment to self-regulation, the enforcement community can and should rely more on self-regulation by companies and less on tactics that are more appropriate to curb street crime.

Editor: Do the current "hard ball" tactics of the enforcement community deter investment?

Ide: One of the reasons for the success of our free enterprise system is that investors need certainty - and because the rule of law has in the past provided that certainty, people have felt it was safe to invest in American companies and our economy has thrived. As the rule of law is weakened in any sector, investors will find other things to do with their money. It is said that foreign investors have been deterred from investing in the U.S. because of the uncertainties of our tort system.

Today, it is a present reality that a company can be wiped out by the mere threat of indictment - and that threat can come from both federal and state prosecutors so that the uncertainty is compounded by the fact that the fate of companies is in the hands of many individual prosecutors whose judgment can be affected by their political ambitions. As a result, our economy could suffer from the current enforcement climate which produces unnecessary uncertainty of unwarranted damaging indictments.

Editor: Do these tactics not only mindlessly destroy jobs and wipe out shareholders and investors, but also have other significant adverse impacts on the economy?

Ide: Criminal law when directed against corporations should not be blind to the consequences for innocent people associated with the corporation such as employees and shareholders. Arthur Andersen is the classic example of the ability of an indictment to destroy jobs. There, the indictment turned on alleged wrongdoing by a single low level member of its law department. And, long after Andersen's demise, the case was thrown out by the U.S. Supreme Court. The death of a major company not only affects its employees and shareholders, it releases unnecessary waves of destruction throughout the economy affecting suppliers, lenders and other investors, customers and the competitive balance in an industry.

Editor: Do the tactics associated with criminal enforcement slow the process of reform by deterring self-regulation?

Ide: Ours is a free enterprise economy that has countless businesses. The use of criminal prosecutions against corporations is not nearly as effective as the kind of broad impact that self-regulation can and has had.

It is imperative that communications of corporate personnel with counsel for a company be protected by the attorney-client privilege. Otherwise, concerns about compliance issues will not be shared with counsel for the corporation.

Another important aid to compliance is the ability of a corporation to indemnify its employees against litigation expense. If employees feel that they will be indemnified, they will be more forthcoming about disclosing compliance failures that may trigger litigation in which they might become involved as a witness or a party. Providing such indemnification also builds the kind of morale that contributes to making a company's compliance program successful.

The enforcement community has sought to take control of these important tools and that would greatly chill the ability to have self-compliance regulations.

The ABA Task Force has had success in helping influence the formal changes in DOJ policy reflected in the McNulty Memo to reduce, but not fully eliminate these intrusions.

Editor: How can the situation be improved?

Ide: The SEC is more geared towards protecting the shareholders. It wants to correct problems and make sure that controls are in place while keeping the company intact for shareholders. For example, the SEC has enlisted the aid of the auditors through Section 10A of the Securities Exchange Act, which provides that if an auditor detects an illegal act, it tells the audit committee to remediate it. If the company responds properly, the auditor need not take any further action. If it does not respond appropriately, the auditor is then required to go to the SEC. That is a healthy approach because corporations know best about what happens in their organizations. Remediation is value added for the companies. Behind the scenes, I see Section 10A promoting a closer relationship between auditors and audit committees.

If you look at the DOJ's ability to regulate corporate conduct, the same skills and needed techniques are not present. DOJ is used to going after major criminals and knows how to blast its way to get the information. I do not believe that the DOJ blast the doors down approach works well in the corporate world.

If the enforcement community is going to be in the game of regulating corporations, there must be policies in place that limit the circumstances in which indictments can be brought against the entity as opposed to the individual wrongdoers. Prosecutors should not be in a position where a company is intimidated into doing whatever they think will please the prosecutor, including waiving the privilege and not indemnifying employees.

Editor: Do you foresee the ABA Task Force encouraging such policy changes?

Ide: The ABA Task Force will not get into what the policy should be with respect to corporations and indictments, but business groups are starting to talk about it. I have urged the National Legal Center for the Public Interest to concern itself with this area.

As I mentioned, the way the SEC operates is to restore companies to health. If there is a cancer in the body, you take the cancer out but leave the body intact. If a rogue officer caused a company to commit an illegal act, the shareholder should not suffer loss except to the extent the shareholder or company benefited from the act. That is where the focus needs to be.

Now is an appropriate time to act because the smoke has cleared from the Enron era. When Enron happened the public wanted retribution. The DOJ, state attorneys general, the SEC and others swung into action. Some good things were done such as remediation by corporations and indictments of individual officers. However, Arthur Andersen was needlessly put out of business and other corporations inappropriately burdened with criminal charges. The pendulum has swung too far, and we need to get it back into the right balance.

We need policy guidelines. It is very important that the interests of the public be taken into account - they are not only employees and shareholders of the company and of the many entities that it touches, but also citizens of the communities in which the company operates. How can it be said that an entity has to be indicted because it is hurting the public - it is part of the public. There needs to be a lot of thought and policy development given to resolving the issues. Criminalization of corporate behavior has become a creeping phenomenon over a long period of time without deep thought and guidance. What is the best way to influence corporate behavior and good governance? The SEC is geared to deal with this, but the DOJ is not.

Editor: What are the points of light on policy development?

Ide: For corporate misbehavior, the SEC has always been there to protect investors. Delaware law provides leadership to other states as to when shareholders can bring suits to protect the company's interests. That has worked well. We had a crisis in 2000 and the enforcement community rushed in without first a public debate on the right policy. We have the mechanisms through the SEC and the civil litigation system. DOJ and state attorneys general should indict individuals causing bad conduct by companies and not companies unless the company itself is a corrupt rogue operation.

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