The Future Of Compliance

A couple of months ago, John Sherman of Harvard's Kennedy School stopped by. He talked about the OECD's new guidelines -- a non-binding code of conduct, he said, that "strengthens the link between compliance, ethics, and human rights."

That link is real news. It means compliance isn't just about staying on the right side of the law. Now it's also about doing the right thing so people won't be hurt.

We knew about John Sherman before his guest post here. He'd written a paper with Amy Lehr published by Harvard last year called 'Human Rights Due Diligence: Is It Too Risky?' It's available here.

One paragraph stood out -- as history and prophesy.

It said:

Although the responsibility to respect human rights is not hard law, its principles have significant potential legal impact. As the reflection of a global social consensus on how business should behave, it is part of a dynamic matrix of international soft and hard law, national law, and transnational custom and customary frameworks (institutionalized or not) that converge into an emerging “lex mercatoria” or law merchant of human rights. This hybrid legal and normative system guides and drives business behavior in the absence of a central global command and control governance structure.

Those words, we think, mark as well as any the start of a new and welcome era of corporate behavior. Where compliance, ethics, and human rights are all part of the same topic.

Naked Corporate Defendants

The Second Circuit Court of Appeals has affirmed the decision in U.S. v. Ionia Management, S.A., shooting down attempts to change the way corporations are held liable for the criminal acts of their employees through respondeat superior. As we've said many times, nothing has had a greater impact on enforcement of the Foreign Corrupt Practices Act against corporations than respondeat superior, which leaves companies defenseless once employees are found to have committed violations.

The amicus brief in Ionia had argued that respondeat superior makes it too easy to impute criminal liability to corporations. But the Second Circuit's three-judge panel (Calabresi, Livingston, McLaughlin) didn't buy the argument. In rejecting the idea that a compliance program should be counted in a company's favor, the court said:

We note that this argument is made only by amici curiae and not by Ionia, and so we are not obligated to consider it. But the argument, whoever made it, is unavailing. Adding such an element is contrary to the precedent of our Circuit on this issue. See Twentieth Century Fox Film Corp., 882 F. 2d at 660 (holding that a compliance program, “however extensive, does not immunize the corporation from liability when its employees, acting within the scope of their authority, fail to comply with the law”). And this remains so regardless of asserted new Supreme Court cases in other areas of the law. As the District Court instructed the jury here, a corporate compliance program may be relevant to whether an employee was acting in the scope of his employment, but it is not a separate element.

So for now, at least, organizations will continue to face vicarious liability for nearly all criminal acts of employees -- even low-level personnel "acting against explicit instructions and in the face of the most robust corporate compliance program," as the amicus brief put it.

But here's the problem: respondeat superior does more harm than good. Sure, it produces a 100% corporate "conviction" rate in FCPA cases, which must go down well at the Justice Department. But, it probably doesn't deter illegal behavior or encourage better compliance programs. And it puts overwhelming pressure on organizations to resolve threatened criminal cases. Because of the catastrophic effects of any potential conviction, companies have to settle with the government. So they rush into agreements that may require them to waive the attorney–client privilege, hand over employees' private documents and data, cut off support for their legal defense, and fire those who don't cooperate with government investigations.

In other words, our criminal justice system is robbing corporations of the chance to defend themselves. What's worse, it's trampling the fragile rights and protections of individuals. That's why respondeat superior needs serious fixing, and soon.

Read the Second Circuit's per curiam opinion in U.S. v. Ionia Management S.A. here.
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In The Master's Defense

As we've said, nothing magnifies the impact of the Foreign Corrupt Practices Act on corporations more than respondeat superior. Latin for "let the master answer," it's the legal doctrine holding companies vicariously liable for crimes committed by employees acting within the scope of their employment. Under it, once an employee admits to an offense or is found guilty, the company is automatically guilty too. Case closed. That gives prosecutors enormous unchecked leverage over corporate defendants.

And that's why we don't know of anything more important to the FCPA these days than the pending case challenging respondeat superior. United States v. Ionia Management, S.A. was argued Friday in the U.S. Court of Appeals for the Second Circuit. But as the Wall Street Journal reports, the three-judge panel (Calabresi, Livingston, McLaughlin) didn't seem too impressed with the appellant's arguments.

Andrew Weissmann, the former Enron prosecutor and current Jenner & Block partner who co-wrote the excellent amicus brief, told the panel that a misreading of a 99-year old Supreme Court case, New York Central v. U.S., has made it too easy to impute criminal liability to corporations. The Journal reported this exchange:

Judge Guido Calabresi called Weissmann’s argument an “interesting” one, saying it appealed to the judges as academics. “Whether we should do something about this as judges is a different matter,” the judge said.

Other than the Justice Department, who benefits from respondeat superior? As the amicus brief puts it, the law imposes vicarious criminal liability on organizations for nearly all criminal acts of employees -- even low-level personnel "acting against explicit instructions and in the face of the most robust corporate compliance program." That sort of hair-trigger liability probably has no added deterrent effect on companies. And the catastrophic consequences of any potential conviction forces them to resolve threatened criminal litigation, without even the possibility of mounting a defense.

That's not how our criminal justice system is supposed to work. Sure, corporate wrongdoers deserve to be punished. Rogue companies bent on breaking the law have to be stopped. But an accused corporation should always have the chance to show a judge or jury that it acted in good faith -- that its overall intention was to comply with the law and not to break it.

Allowing corporations to defend themselves would bring a needed measure of justice. It would also give organizations the strongest possible incentive to maintain an effective compliance program.

It's time to fix respondeat superior -- either in court or in Congress.
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Surveying FCPA Compliance

Eighty percent of U.S. companies have now banned facilitating payments entirely, and nearly four in ten small U.S. companies have walked away from business in countries where the perceived risk of non-compliance was too high.

Those are among the findings of Fulbright & Jaworski's 2008 Litigation Trends Survey. The fifth annual report is based on input from 358 U.S. and U.K. in-house counsel, including 251 U.S. respondents.

Here are some facts from the "Bribery and Foreign Corruption" section of the survey, which is available here:

• Twenty percent of companies with $1 billion or more in revenues undertook a bribery or corruption investigation during the survey period. For companies with less than $1 billion in revenues, the number was 2%, and for companies under $100 million, it was just 1%.

• Manufacturers led all other industry segments in corruption investigations at 14%, followed by energy firms at 12%.

• Seven percent of U.S. companies engaged outside counsel because of possible corruption or bribery charges, including violations of the Foreign Corrupt Practices Act.

• Eleven percent of the responding companies with international operations hired outside counsel during the survey year to investigate bribery claims, and 20% dealt with potential bribery concerns as part of due diligence in a corporate acquisition.

• Only 20% of U.S. companies still allow facilitating payments in some countries as a means of expediting business and government functions.

• In the U.K, 39% of companies still permit facilitating payments.

• Thirteen percent of the responding companies admit they still allow small direct payments to foreign governments in certain specific situations.

• One-quarter of energy companies and one-fifth of financial services firms admitted making direct payments to foreign hosts in some cases.

• Twenty three percent of all U.S. companies said they have made the decision to walk away from doing business in a country based on the perceived degree of local corruption. For companies with under $100 million in revenues, the walk-away rate was 39%, and for billion-dollar companies it was 31%.

A release says the survey was conducted earlier this year (and in the prior four years) by Greenwood Associates, a Houston-based research firm. It canvassed 358 in-house counsel in the U.S. and U.K., more than two-thirds of whom identified themselves as either general counsel or deputy general counsel, with 7% holding the title of senior counsel, 10% associate general counsel, and 15% staff counsel.

The industry groups covered by the survey included financial services, energy, manufacturing, health care, retail, real estate, insurance, education, and technology and telecommunications. By size, 22% of the responding companies report revenues under $100 million, 39% report revenues between $100 million and $999 million, and 39% at $1 billion and above. Just under half the companies are publicly held (a quarter are listed on the NYSE) and 57% maintain at least one foreign office, with 19% having locations in more than 20 countries.

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Charting The FCPA

"Cash crunch could result in more corruption cases," says a headline in the current Financial Week (available here.) In the article, Steven Tyrrell, the head of the Justice Department's fraud section, says the credit crisis may produce a crop of additional Foreign Corrupt Practices Act cases. The targets this time would be banks and others that went looking for cash from sovereign wealth funds in exchange for favors rendered to the host-country's rulers.

"Mr. Tyrrell," the article says, "noted the recent boom of sovereign wealth funds is an area at the top of the Justice Department’s hit list, though it has not yet garnered any definitive cases."

We've never seen empirical studies on the subject, but we've noticed that FCPA cases generally spring from industries that deal in scarce commodities -- whatever those happen to be at any moment in history. It could be energy, telecommunications licenses, access to hospital patients, metals, food, cash and so on.

Wherever buyers are scrambling for supply, sellers have opportunities to squeeze them. Rising energy prices over the past decade, for example, increased the leverage corrupt oil-producing countries could exert over foreign buyers. In her excellent book, Bribery and Extortion, Alexandra Wrage talks about corruption in Nigeria's ruling family during the energy and metals boom. The story is grotesque, and the scenario was repeated in resource-rich, governance-poor countries around the globe. The pressures in energy-related markets eventually resulted in many FCPA enforcement actions, culminating in Jack Stanley's shocking guilty plea last month.

These days, a commodity in short supply is cash. Sovereign wealth funds have it and banks need it. Will the financial institutions succumb to market pressures? Will they abandon FCPA compliance to save their balance sheets? Some might, as the DOJ's Steven Tyrrell predicts. And if that happens, pin-striped tragedies are sure to follow.

We don't have empirical evidence for this one either. But we're fairly certain that anyone who has ever occupied a jail cell because of an FCPA offense wishes they'd complied instead.

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