Welcome back to the Conglomerate Junior Scholars Workshop. Our paper today is Insuring Corporate Crime by Miriam Baer. Miriam is an Acting Assistant Professor in NYU's Lawyering Program. She also is well-acquainted with her topic; Miriam was an assistant U.S. attorney in the Southern District of New York from 1999 to 2004. Our commentators today are also experts on this topic: Sean Griffith, Kim Krawiec and former workshop participant and commentator Mike Guttentag. I will post the comments of these experts below this post. We invite readers to comment on the paper (and the comments) in the comments section of this post. In the interest of running this workshop like a physical world conference, no anonymous commenters, please.
The abstract for the paper is here:
Corporate criminal liability has become an important and much-talked about topic. This Article argues that entity-based liability - particularly the manner in which it is currently applied by the federal government - creates social costs in excess of its benefits. To help companies better deter employee crime, the Article suggests the abolition of entity-wide criminal liability, and in its place, the adoption of an insurance system, whereby carriers would examine corporate compliance programs, estimate the risk that a corporation's employees would commit crimes, and then charge companies for insuring those risks. The insurance would cover the entity's civil penalties associated with its employees' criminal conduct. Entities that successfully procured insurance would no longer be subject to entity-wide criminal liability. Part I begins with a discussion of corporate criminal liability and the costs that accrue from the manner in which it has been implemented by the Department of Justice. Part II examines several proposals to reform corporate criminal liability and explains why they are inadequate. Part III lays out the proposal for an insurance system in lieu of entity-based criminal liability and explains, in rough form, how corporate entities might contract for insurance, how claims might be filed and how damages might be measured. Part III also addresses a number of arguments that others might raise against the proposal.
TrackBack URL for this entry:
Links to weblogs that reference Conglomerate Junior Scholars Workshop: Miriam Baer's Insuring Corporate Crime:
1. Posted by Miriam Baer on June 27, 2007 @ 11:48 | Permalink
Let me echo David Friedman’s comments on Monday by saying how thankful I am to Christine Hurt and the Conglomerate for hosting my paper and to Professors Griffith, Krawiec and Guttentag for reading my article so thoroughly and for responding with such some very helpful (and challenging) comments and suggestions. I will address Professor Guttentag’s comments in this post and then Professors Krawiec’s and Griffith’s comments in separate posts.
I agree with Guttentag’s observation that the argument would be strengthened if I could show “how large” the overpayment is for corporate criminal liability. This is no small task unfortunately. Defenders of corporate criminal liability often look only at the number of entity-level prosecutions (quite small) or Deferred Prosecution Agreements (also fairly small, but has increased significantly over the last five years, as detailed in Finder and McConnell’s article, Devolution of Authority, 51 St. Louis U. L. J. 1 (2006)). But these measures are too limited, since all corporations take ex ante steps (hiring compliance consultants for example) and reduced risk-taking to avoid corporate criminal liability. I draw some support for my argument from individual prosecutions whose settlements appear to be suboptimal (such as the BMS prosecution) as well as the growth of the Compliance Industry (which Professor Krawiec has noted in her own work), which might eventually provide a hint as to how much overpayment exists assuming corporate crime remains fairly constant over time while compliance costs escalate. In the same vein, Lisa Fairfax linked to an interesting paper in a post she made on this blog last week. The paper, written by Leonce Bargeron, Kenneth Lehn and Chad Zutter, was presented to the Amercian Enterprise institute and is entitled “Sarbanes Oxley and Corporate Risk-Taking.”(June 18, 2007) (Lisa posted this on June 20, 2007). According to the authors, “US firms have significantly reduced their R&D and capital expenditures and significantly increased their cash holdings since Sox.” (1). If managers are taking fewer risks because their fear the impact of Sarbanes Oxley, then it is at least as possible that some of the reduced risk-taking is fueled by the fear of corporate criminal liability (the enforcement of which rose alongside with Sox).
Finally (and somewhat ironically), it may well be that the true test of whether there exists a problem (overpayment for corporate criminal liability) and the extent of that problem, might be proved (or disproved) by enacting the proposed solution. If corporate criminal liability remained a default rule and public companies were offered the opportunity to opt out by purchasing Compliance Insurance, we might get a better sense of: (a) whether the overpayment is real or whether it’s overblown; (b) whether the overpayment theory is at least applicable in certain industries (which seems likely since the collateral consequences of an indictment can vary depending on the industry in which a company operates; and (c) whether Compliance Insurance offers a better alternative.
One last point in response to Mike’s comments: Mike queries why we cannot have other opt-outs besides insurance (such as a bond or reserve). This question dovetails nicely with Sean’s question as to why I think shareholders would value Compliance Insurance. There are a number of reasons (which I will address below), but suffice it to say that, quite apart from the monitoring benefits that I presume (or hope?) carriers would bring to the table, I would in any event prefer an insurance market to determine the correct amount of money necessary to put aside to cover losses caused by employee crimes than to have some central authority set (and re-set) the proper bond or restitution/reserve amount that the company must set aside. On the other hand, it is certainly useful to consider other alternatives besides compliance insurance.
2. Posted by Miriam Baer on June 27, 2007 @ 11:55 | Permalink
Response to Professor Krawiec:
As Kim Krawiec deftly points out, many of the issues that pervade corporate criminal liability also pervade corporate civil liability. This criticism is quite valid and demonstrates to me that I should address it head-on in the text of the Article. (And I would very much like to take her up on her offer for direction to literature that discusses compliance-based civil liability in employment discrimination and other contexts).
So here is a very brief (and still evolving) answer to Professor Krawiec’s comments, the crux of which is that the inefficiencies that currently attach to corporate criminal liability for employee crimes would just as soon attach to corporate civil liability for employee crimes:
Assuming they continued to exist, the inefficiencies would be lesser: I still think a good argument can be made that the inefficiencies that juries and judge introduce into the civil system would be lesser in degree and kind than the inefficiencies that prosecutors introduce into the criminal system – particularly in certain industries. Jury verdicts and judicial decisions can be appealed and catastrophic money judgments can at least be spread out over time through insurance (more on that later). By contrast, as the employees of Arthur Andersen can attest, for many companies the dire consequences of indictment last forever. And whereas the aforementioned checks on juries and judges presumably temper their worst biases and heuristics (just as the market presumably restrains the worst biases of the carriers themselves), the prosecutor is subject to virtually no checks (and no competition) since her decision to indict is effectively unreviewable.
The Insurance Carrier might temper these inefficiencies: Assuming insurers took an active role in litigation (and I know from Sean’s work that they currently do not in the D&O context, but I think it is at least possible that they would if they had the backdrop of corporate criminal liability as a default), they too might be less interested in paying for settlements or monitoring systems that are ultimately more costly (and showy) than beneficial.
Strict liability has its problems too: If I seem reluctant to adopt Krawiec’s fix, it is because I worry that it heads back into pure strict liability (I am assuming that she would agree that full blown negligence liability is just as bad as the current regime, if not worse), which is at least possible in the civil context (in the criminal context the collateral consequences are simply too high and the government has to build “mitigation” into its standard), which Arlen and Kraakman have pointed out creates its own perverse incentives. One possible solution might be to keep some form of mitigation, but make it much clearer and less contextual. In other words, use kind of well-defined straight-foward rule (all crimes reported prior to X period in time will result in Y% mitigation) and then make it transparent to all parties.
3. Posted by Miriam Baer on June 27, 2007 @ 12:01 | Permalink
Response to Professor Griffith:
I am additionally thankful to Sean for his succinct summary of my article and for his insightful challenge to explain why I think Compliance Insurers will do a better job monitoring firms than D&O carriers do right now.
As an initial matter, I think it is important to distinguish how Compliance Insurance would work in a hypothetical world from how D&O insurance operates in our current world. Compliance Insurance would exist as an alternative to corporate (entity-level) criminal liability. It would cover only the entity and would leave managers and directors subject to individual criminal liability.
D&O insurance, by contrast, operates under the current backdrop of criminal liability (although it excludes criminal claims) and is intended primarily to cover Directors and Officers. (The entity also obtains coverage on Sides B and C of the policy). D&O insurance does such a good job of shielding outside directors that, according to Professor Black et al, outside directors rarely pay for managerial wrongdoing. Assuming D&O insurance is properly drafted and maintained, the average outside director can look forward to a lifetime of no civil liability assuming he does not directly participate in corporate wrongdoing.
Professors Griffith and Baker found in their analysis that although D&O carriers monitored companies for compliance risks and offered services to companies to decrease those risks, most companies were uninterested in paying for these services. From this fact, Griffith and Baker hypothesized that corporations purchase D&O insurance primarily to protect managers and directors. So, Sean properly questions why we should expect monitoring in the hypothetical Compliance Insurance context when we clearly don’t get that in the current D&O context.
The Current D&O World
This is an important question and I will try to amplify my answers to it in future revisions of my Article. My first thought was that the perverse incentives not to monitor that Professors Arlen and Kraakman identified years ago might well prompt the corporations to forego monitoring from carriers. Professor Griffith counters by suggesting that while Arlen and Kraakman’s theory makes sense in the criminal context, it makes less sense in the civil context, where monitoring might prevent wrongdoing altogether or, at the very least, reduce the liability associated with that wrongdoing. The problem with that argument, however, is that the corporation cannot know in advance: (a) how bad the internal problem is; (b) whether it will be treated civilly or criminally (Griffith’s example, channel stuffing, could support either a criminal or civil claim); (c) when in its “lifetime” the problem will be detected by the carrier. Moreover, given the uncertainty surrounding the manner by which prosecutors apply the McNulty/Thompson Memo, it is not at all surprising that corporations would shy away from additional monitoring by carriers. Another reason why corporations are currently unlikely to pay for extra monitoring by carriers is that corporations currently have no incentive to do so. If compliance fails, then the corporation will be looking at criminal liability, which the D&O carrier cannot insure in any event. Moreover, if compliance fails, the only decision-maker that will matter to the corporate entity is the prosecutor. The corporation must convince the prosecutor that it took sufficient proactive steps (e.g., compliance programs) and reactive steps (cooperation and waiver of attorney client privilege) to merit prosecutorial lenience. Accordingly, the corporation will have already “paid” for such lenience through programs that it already implemented on the advice of the various “ethics experts” that have blossomed since the passage of Sarbanes-Oxley and the government’s increase in prosecutions. If it already paid for this advice and already erected the showy compliance program to make the prosecutor happy, the corporation is not going to want to pay additional money for advice from a carrier.
The Hypothetical Compliance World
Professor Griffith is right, however, that I still need to better explain how Compliance Insurance might benefit shareholders. Here are several thoughts, which will be set forth in some detail in future revisions of the paper:
Monitoring: In the hypothetical world that I imagine, the Compliance Insurance carrier can act as an outside monitor on the company but be less subject to capture than an auditor and be better bonded with the shareholder because the carrier is responsible for the payout if wrongdoing occurs. If companies are deciding between a default (criminal liability and the uncertainty of prosecutorial lenience) and Compliance Insurance with monitoring, I am (admittedly) betting on the likelihood that many public companies will choose the latter.
Loss prevention: Compliance Insurance carriers can improve the market as a whole by collecting and processing information about corporate governance and compliance structures. This is a slightly different concept from monitoring. One of the great critiques of the corporate governance movement (Paul Rose’s article on the Corporate Governance Industry, which will come out in Volume 32 of the Journal of Corporation Law (2007), available at http://ssrn.com/abstract=902900 was very effective on this) is that politicians glom onto certain corporate governance ideas without any real proof that they lead to better governance. Compliance Insurance carriers could act similarly to liability insurers (eg, fire prevention) by collecting and providing real information on different governance metrics over time.
Risk Aversion: Assume for a minute that carriers either cannot or will not detect wrongdoing through monitoring. In that case, according to Professor Griffith, their only benefit is that they spread risk and loss, and since that function costs money, shareholders would be better off diversifying their portfolios. This conclusion, however, does not take into account the beneficial effect that insurance provides for managers, particularly where legal standards (as here) are uncertain. Ehud Kamar addressed this in his 1999 article, Shareholder Litigation Under Indeterminate Corporate Law, 66 U Chi. L. Rev. 887, 889-90 (1999). Kamar suggests that insurance reduces negative byproducts of risk aversion whereby managers who are risk averse (and therefore overreact to infrequent and uncertain high sanctions) become more efficient in light of more frequent (but smaller) payouts.
Sean might respond that Compliance Insurance does more than soften the manager’s risk aversion; it increases moral hazard by shifting the risk onto someone else. However, at least in the Compliance Insurance context, it seems to me that Compliance Insurance would not increase moral hazard because managers would remain individually subject to criminal prosecution and all the collateral effects of a criminal or regulatory investigation (all of which are pretty grim, according to the latest version of the costs of book-cooking that Jonathan Karpoff, Scott Lee and Gerald Martin detailed in their paper, The Consequences to Managers for Financial Misrepresntation, (2007), which is available on SSRN at http://ssrn.com/abstract=972607 ). Granted, some of these individual collateral consequences might abate if we took entity-level criminal liability off the table. Nevertheless, I cannot imagine that any corporate manager wants to deal with the stress of FBI and SEC interviews, press inquiries, search warrants and subpoenas, and, if all goes truly wrong, the Bernie-Ebbersesque lifetime sentence in federal prison.
One other point on diversification: some shareholders (employees for example) cannot effectively diversify. It seems to me that these type of shareholders would greatly prefer Compliance Insurance to the current regime, or even a large corporate tort payout.
Reserves: Finally, one additional reason why the insurance system might be preferable to a straight corporate tort payoff is that insurance creates reserves for compensation. I suppose we could require companies to reserve amounts for compliance-related claims, but this strikes me as far more difficult and inefficient than directing companies to purchase a certain amount of insurance.
Politics: Although it is wonderful to see so much positive support from the Conglomerate community for this idea, I realistic enough to know that it is (sadly) quite unlikely that Congress will do away with corporate criminal liability. However, I do think that the insurance intermediary proposal is far more palatable than a straight corporate tort proposal. Although political concerns, in and of themselves, hardly support such a proposal, these benefits nevertheless should at least be considered.
4. Posted by Mike Guttentag on June 27, 2007 @ 15:12 | Permalink
Professor Baer. Thank you for your thoughtful response. One of the questions that I am still curious about is whether you think it would be beneficial to make only one change in the current system, namely to change sentencing guidelines so that they reward purchasing a certain amount of compliance insurance rather than implementing monitoring and compliance systems. I understand this may be the topic for different paper.
5. Posted by Miriam Baer on June 27, 2007 @ 15:36 | Permalink
I should be thanking you for the thoughtful read of my paper. This has been a great process.
In answer to your question, no I would not find a change in the Sentencing Guidelines particularly helpful here, because for most companies, the end game is avoiding indictment altogether due to the collateral consequences of being indicted, defending an investigation etc. My preference is to grant the "benefit" to the corporation pre-Indictment: purchase a minimum amt of insurance and you get to opt out of the entity-based criminal liability system altogether.
6. Posted by Lisa Fairfax on June 27, 2007 @ 16:03 | Permalink
Miriam, I agree with everyone else that this is a thoughtful paper that very nicely lays out some of the problems with the current corporate criminal liability regime, and proposes I think a very interesting solution. I also think you have gotten some nice feedback about the viability of that solution.
My question/comment relates to the very first criticism you anticipate with your proposal. That is, will your compliance system, or any system that takes away the government's ability to criminally prosecute corporations, reduce the government's ability to effectively prosecute individual corporate officers? I think you do not delve enough into this question even though it is potentially a significant drawback to your proposal.
Certainly, one compelling story about corporate criminal liability (which I believe adds to the legitimacy of such liability) is that it has facilitated the prosecution of corporate employees, particularly high-level employees. As the story goes, it has been especially difficult to hold high-level employees liable for their crimes because it has been difficult to tie them to criminal conduct, and this difficulty has been enhanced by the kind of wall of silence that corporations create for their employees. Apparently, the threat of criminal prosecution has been a powerful force in breaking down that wall, and providing the government with the information it needs to go after corporate executives. Moreover, particularly given the fate of Arthur Andersen, this threat is much more powerful than any in the civil context. To be sure, I think you do point out that the government has not really proven that its "success" with individual prosecutions stems from its ability to impose enterprise liability. And you also point that corporations may just be scapegoating individual employees. Yet you do not really refute the story head on--and maybe there is not enough evidence to do so. However, the story is a powerful one and without doing more to at least poke holes in it, you will get resistance from those readers who believe that enterprise liability plays an important role in the government's ability to hold individual officers liability for corporate misconduct.
7. Posted by Miriam Baer on June 27, 2007 @ 16:32 | Permalink
I do agree with you that the strongest resistance to my proposal will most likely come from those who fear that the lack of criminal enterprise liability will reduce the government's ability to prosecute individual executives who have committed crimes. I will attempt to do a better job of refuting that contention in my article, but here is an abbreviated preview:
To prosecute an executive for wrongdoing, the prosecutor needs witnesses and documents. Whistleblowers and cooperating defendants are the primary reasons why Bernie Ebbers, Jeffrey Skilling and other well-known corporate defendants were convicted and sent to prison. The government attracts cooperating defendants, in turn, because of the high (individual) sentences built into the Federal Sentencing Guidelines.
In addition to witnesses, the government also needs documents to prosecute individual defendants. However, the government has tremendous power to obtain these documents, through subpoenas, various reporting requirements and search warrants.
Nothing in my proposal alters the government's access to its two most important sources of conviction, documents and witnesses. Moreover, to prevent companies from affirmatively obstructing justice, the government could impose successively punitive civil measures up to and including debarment or loss of licenses to operate. The difference, however, is that there would be some for the government to calibrate its response (something like the Ayres/Braithwaite Responsive Regulation analysis), whereas now, the government starts out the conversation with a huge gun held to the corporation's head.
8. Posted by Miriam Baer on June 27, 2007 @ 16:43 | Permalink
Let me also add an additional point to my response to Lisa's post:
Either before or after enacting a Compliance Insurance system, the government could increase indvidual liability for obstructive-type offenses if it credibly feared that the lack of enterprise liability would cause corporate actors to increase obstructive conduct and interfere with the government's ability to investigate defendants.
9. Posted by Jake on June 27, 2007 @ 19:51 | Permalink
I apologize for commenting under my Internet nom de plume, contrary to Christine's admonition, but this is the only way I can weigh in on the matter.
Ms. Baer has written a great article. My chief quibble is that insurance is an incomplete solution to corporate criminal liability. Evidently we are to believe that a corporation formed for the purpose of committing murder could insure away its criminal liability.
I note a parallel (weak, perhaps, but worth considering) to the debate over whether firms should be allowed to patent aggressive tax strategies.
10. Posted by miriam baer on June 27, 2007 @ 20:43 | Permalink
Jake, a corporation "formed for the purpose of committing murder" would: (a) still be liable under RICO (my proposal leaves untouched purely criminal enterprises that hide under the corporate form), and (b) would not likely find any carrier willing to insure it.