'Tis the season for article submissions, and I am nothing but a joiner. Here is my latest piece, hot off of SSRN, "The Hostile Poison Pill":
Whether one ascribes to the agency theory of shareholder primacy or the contractarian theory of director primacy, boards of directors have great discretion in determining whether, when, and how to sell the corporation. Defensive tactics, like poison pills, can be tools in wielding that discretion in the service of creating shareholder value. However, a poison pill either to oppress a minority shareholder, as in eBay v. Newmark, or to minimize the impact of activist shareholders, as in Versata Enterprises, Inc. v. Selectica, Inc., seems to exceed the “maximum dosage” of the pill. The NOL poison pill, while facially plausible as a tool to protect tax assets from impairment caused by a Section 382 “ownership change,” may be a stepping stone to a low-trigger anti-shareholder pill. Instead of warding off uninvited potential acquirers, the pill could ward off shareholder voice. Though the original poison pills were blessed by the Delaware courts to ward off hostile bidders, now boards can use a hostile poison pill to ward off noisy shareholders. With the threat of the 1980s-era hostile bidder behind us, a new threat to board authority has emerged: the activist shareholder. These types of investors, often activist hedge funds, agitate not for control of a corporation, but for access to the board to argue for changes in strategy. Defensive tools used against hostile bidders at first seem inapplicable to these types of nuisances; staggered boards and poison pills with typical 15-20% triggers seem irrelevant. However, a pair of cases decided in Delaware may give managers an idea of how to cope with these aggressive blockholders. One case, Air Products and Chemicals, Inc. v. Airgas, Inc., allowed a company’s board to keep a poison pill in place for over a year even though the bidder did not seem to pose much of a cognizable threat to the corporation. By itself, Airgas does not seem to give much relief to a board dealing with a noisy 5% or 10% shareholder. However, the Delaware Supreme Court the year earlier had blessed a poison pill that would be triggered if a shareholder increased its ownership to 4.99% of the corporation, the lowest ownership threshold to be brought before the court. In Versata Enterprises, Inc. v. Selectica, Inc., the Delaware court upheld the poison pill even though the board did not focus its argument on the threat of a takeover. In this case, the “danger to corporate policy and effectiveness” existed because of the activist shareholder’s creeping purchases would constitute an “ownership change” under existing federal tax law and would lead to the loss of certain tax assets, net operating loss carryovers (NOLs). Because the NOLs were a very large, if unusable, asset to Selectica that would be severely limited under Section 382 of the Internal Revenue Code if the ownership change occurred, the court held that the low-trigger rights plan was reasonable and proportionate against a legitimate threat. Together, these cases seem to suggest a new weapon to be used against activist shareholders: a poison pill with a very low trigger. Unfortunately, the Delaware courts took at face value Selectica’s argument that the creeping acquisition could involuntarily cause the target company to lose a large tax asset. The Unocal test is supposed to require the board to articulate its rationale for implementing a defensive tactic, foreclosing the opportunity for pretextual arguments. However, this analytical technique may not work in the NOL context where the presence of NOLs may give a board of directors cover for keeping blockholders away. This Article attempts to shed some light on the operation of Section 382 to disclose some of the faulty assumptions surrounding both the necessity and efficacy of the NOL poison pill. In addition, this Article uses a dataset of 155 companies that adopted NOL poison pills between 1998 and 2014 to examine what types of firms are using this defensive tactic. A board might argue in good faith or not that an NOL poison pill is necessary to defend itself against a strange and diverse cast of characters: the Hostile Acquirer, the Accidental Bungler and the Bad Faith Saboteur. However, an NOL poison pill necessarily has little or no deterrent effect and no physical effect against any of these actors. In fact, the only shareholder that the NOL poison pill effectively deters is the activist shareholder, suggesting that the use of the poison pill in these cases may be “hostile.”
Workers have become so divorced from the "corporation," in the eyes of many corporate law and finance scholars, that efforts to advocate on their behalf are signs of bad corporate governance. At least, that seems to be the message of "Opportunistic Proposals by Union Shareholders," a new paper by Matsusaka, Ozbas & Yi (USC Marshall School of Business). The titular "opportunism" refers to union efforts to use shareholder proposals to get a better deal for their represented workers. The narrative is this: almost half of union shareholder proposals concern executive compensation (46%, versus 28% of nonunion proposals). Unions are 4.7% more likely to bring shareholder proposals during a year when they are negotiating a new collective bargaining agreement with the company. Unions then use these proposals as bargaining chips with management during negotiations. The study found that wage increases are 0.22 percent higher following negotiations with a withdrawn union proposal than they are when the proposal goes to a vote.I want to put aside, for this post, any concerns about the strength of the study's results to ask a simple question: assuming the narrative is correct, what's wrong with that? When unions are negotiating wages and benefits for their own members, as part of their strategy they call attention to the wages and benefits that executives are making. Is that bad? That seems to me to be exactly what unions should do. I suppose it's bad for shareholders if the union negotiates a better deal, but let's pause on that for a second. First, if a wage increase leads to less turnover and more productive workers, wouldn't that be better for shareholders? Second, if you think a wage increase would generally just be a waste of shareholder profits, then why doesn't this logic also apply to executive compensation? If you are the representative for some of the employees, wouldn't it make sense to point out to shareholders that another group of employees is making a lot of money -- much more, in most cases, than the employees that you represent? And so how are shareholders harmed when unions introduce (hortatory) proposals to limit executive compensation? If anything, management should be blamed for buying off the union in order to avoid scrutiny for their own sweet deals. But that's an argument for more frequent and routine scrutiny for executive compensation. If other shareholders don't care about executive compensation, then the union's proposal is powerless.
The good Professor Bainbridge links to this study, and the related CLS Blue Sky Blog post, as further proof that unions nefariously manipulate their shareholder rights to get "private" benefits. Only in modern day corporate law scholarship could there be anything nefarious about employee efforts to get better wages by publicizing how much management rakes in. But his post also mentions, yet again, the 2004 CalPERS-Safeway imbroglio as an example of the horrifying things that unions unchained will unleash upon the citizenry. I would love to drive a stake through the heart of this Safeway example, at least when it comes to the awesomeness of union shareholder power. As Grant Hayden and I discuss in The Bizarre Law and Economics of Business Roundtable v. SEC, 38 J. Corp. L. 101, 130-31 (2012):
Please, no more Safeway!
Notes (taken from Westlaw):
Last week, the NY Times did a piece on Dan Price, CEO of Gravity Payments, who announced in April that each of his employees should make at least $70,000 a year. You might think that this announcement would make him a very popular figure, but I guess you would be wrong. Polarizing, maybe. Story here. You can read the details, but Price, who was raised in a very religious home, believed very strongly in creating an atmosphere in which employees would not need to worry about basic human needs and therefore be more productive and creative and happy. Where would the new money come from? Well, from his own salary, leveling the pay chart. But not everyone is happy.
Here is probably an incomplete list of the haters: (1) clients who feared their bills would be increased to cover the shortfall; (2) other employers who compete in the labor market; (3) other employers who don't compete for the same labor but who don't want to look bad; (4) Gravity Payments employees who feel that some employees don't deserve $70,000; and (5) Dan's brother and co-founder Lucas Price who feels that as a shareholder, he is being denied a return on his investment. That last number (5) reminds us corporate law geeks a little of Dodge v. Ford. I'm also interested in number (4), having written before on the hatred of so-called "windfalls."
Price v. Price. Here is the complaint. It is brief, and the answer is more brief. The brothers started the company as a 50/50 LLC in 2004. After disagreements, the brothers reorganized as a corporation in 2008, with Daniel having a majority share. This would seem to be a definitive moment for Lucas and possibly his downfall. The complaint does not give any hints as to why Lucas would agree to this, but there must be more to the story -- My brother was trying to grab control of the company, so we reorganized and gave him control to solve the problem? As part of the reorganization, the brothers entered into a Shareholders Agreement, which is not attached. The causes of action are breach of fiduciary duty, not breach of the agreement. The complaint states that Daniel used his majority control to grant himself "excessive compensation and to deprive Lucas of the benefits of ownership in Gravity Payments. Daniel's actions have been burdensome, harsh, and wrongful, and have shown a lack of fair dealing toward Lucas." The complaint does not give examples of the wrongful actions. The complaint was filed shortly after the minimum wage announcement, but had been in the works before. Further litigation may flesh out whether this complaint has a future, but shareholder oppression is a hard case to make out. Most notably, and possibly good news for Lucas, Gravity Payments is a Washington corporation, not a Delaware corporation. Lucas wants, among other things, either dissolution or to be bought out without a minority/marketability discount. Corporations aren't partnerships, Lucas. Dissolution seems a stretch. How does this affect Daniel's minimum wage plan? Well, he wasn't counting on having high litigation expenses when he changed the salary structure.
Employee Envy. According to the article, several employees have left Gravity Payments because they suddenly felt undervalued when junior employees and recent hires received raises, even though they themselves did also. When I wrote The Windfall Myth, I researched the use of the term "windfall" in the NYT and WSJ in a 12-month period. I was astounded at the depth of bitterness people have against other people's "windfalls," even when the windfall does not affect the observer at all. Hundreds or thousands of experiments have tried to capture why subjects will give up money if they believe under that regime others will get more (the Ultimatum Game). Here, GP employees were given raises, but others were given larger ones, and some small raise receivers left for jobs that paid less.
This story is a great case study in how to tackle wealth inequality in the U.S., where a fidelity to pure meritocracy is heavily ingrained. Even when the founder and CEO is willing to reduce the salary disparity at his company, some of his employees were not. Fascinating.
I just posted a new paper on SSRN entitled "The Modern Business Judgment Rule." It's short, so it won't take long to read, especially if you skip the footnotes. My goal is to describe this complex doctrine in simple terms, but the paper is packed with insights that were new to me, even though I have been teaching and writing about this subject for 20 years. Here is the abstract:
For over 150 years, the business judgment rule performed a relatively straightforward task in the corporate governance system of the United States, namely, protecting corporate directors from liability for honest mistakes. Under the traditional version of the business judgment rule, when the board of directors is careful, loyal, and acting in good faith, courts refuse to second-guess the merits of the board’s decisions, even if the corporation or its shareholders are harmed by those decisions.
While modern courts continue to insulate directors from liability for honest mistakes according to this traditional formula, in the 1980s Delaware courts began assigning the business judgment rule a more expansive role. The modern business judgment rule is applied not only in cases without procedural infirmities, but in cases where procedural infirmities at the board level have been mitigated by a special committee, stockholder approval, or partial substantive review by the court. In these new contexts, a court must satisfy itself that a board decision is worthy of respect, not because the decision was substantively correct, but because the effect of the procedural infirmities was sufficiently muted. After the court reaches that point, the business judgment rule “attaches” to protect the substantive merits of the decision from (further) review.
The modern business judgment rule is not a one-size-fits-all doctrine, but rather a movable boundary, marking the shifting line between judicial scrutiny and judicial deference. In describing the transformation of the business judgment rule, this chapter focuses on Delaware judicial opinions, with special attention to cases involving mergers and acquisitions, where the most important changes in the business judgment rule have been forged. The scripting of the business judgment rule’s new role by the Delaware courts is a work in progress, and the current law is inconsistent and confusing. Nevertheless, I trace the development of the modern business judgment rule and attempt to rationalize that development around the simple idea that the rule guides courts through the review of director conduct and marks the point at which judicial evaluation of a decision ends.
I hope you find this paper worthwhile. Comments and insights are most welcome.
During the previous three academic years (2011-2012 through 2013-2014), the SRP operated a clinic that assisted institutional investors (several public pension funds and a foundation) in moving S&P 500 and Fortune 500 companies towards annual elections. This work contributed to board declassification at about 100 S&P 500 and Fortune 500 companies. With work on the declassification project completed last summer, the clinic has not been operating during the current academic year. This website provides information about the work done by the SRP clinic during its three years of operation; a detailed final report on this work will be issued in 2015.
The clinic has indeed changed a great deal about corporate governance; it was also the target of that paper by Gallagher and Grundfest about whether it had conducted securities fraud in its various proxy campaigns by not discussing research that did not support its position on staggered boards, a paper with less importance, perhaps, if the thing it was complaining about was no longer in existence. I thought the project was interesting, in that it was actually giving students a chance, it seemed to me, to do corporate law in a clinical setting, which is difficult to pull off. But perhaps it was at the natural end of its efforts anyway.
Deferred Prosecution Agreements have been in vogue since the unwarranted death of Arthur Andersen, and over at Jotwell, Larry Mitchell glosses Larry Cunningham's take on what to do about them. A taste:
DPAs can be useful, he tells us, but only if prosecutors approach the negotiation and structuring of an agreement as a governance problem. Ever since the 1996 Delaware Caremark decision, Delaware law at least formally has required that its corporations structure governance in a manner that discourages unlawful conduct and that makes it detectable when it occurs. Sarbanes-Oxley supplemented this approach with its own regulations. And who better to understand the governance of any particular corporation than its own board and executives?
It has been a pleasure to guest-blog for the last two weeks here at the Glom. (Previous posts available here: one, two, three, four, five, six, seven, eight, and nine.) This final post will introduce the book that Lynn Stout and I propose writing to give better direction to business people in search of ethical outcomes and to support the teaching of ethics in business schools.
Sometimes bad ethical behavior is simply the result of making obviously poor decisions. Consider the very human case of Jonathan Burrows, the former managing director at Blackrock Assets group. Burrows’s two mansions outside London were worth over $6 million U.S., but he ducked paying a little over $22 U.S. in train fare each way to the City for five years. Perhaps Burrows had calculated that being fined would be less expensive than the inconvenience of complying with the train fare rules. Unluckily, the size of his $67,200 U.S total repayment caught the eye of Britain’s Financial Conduct Authority, which banned Burrows from the country’s financial industry for life. That’s how we know about his story.
But how do small bad ethical choices snowball into large-scale frauds? How do we go from dishonesty about a $22 train ticket to a $22 trillion loss in the financial crisis? We know that, once they cross their thresholds for misconduct, individuals find it easier and easier to justify misconduct that adds up and can become more serious. And we know that there is a problem with the incentive structure within organizations that allows larger crises to happen. How do we reach the next generation of corporate leaders to help them make different decisions?
Business schools still largely fail to teach about ethics and legal duties. In fact, research finds “a negative relationship between the resources schools possess and the presence of a required ethics course.” Moreover, psychological studies demonstrate that the teaching of economics without a strong ethical component contributes to a “culture of greed.” Too often business-school cases, especially about entrepreneurs, venerate the individual who bends or breaks the rules for competitive advantage as long as the profit and loss numbers work out. And we fail to talk enough about the positive aspects of being ethical in the workplace. The situation is so bad that Luigi Zingales of the University of Chicago asks point-blank if business schools incubate criminals.
New business-school accreditation guidelines adopted in April 2013 will put specific pressure on schools to describe how they address business ethics. Because business schools are accredited in staggered five-year cycles, every business school that is a member of the international accreditation agency will have to adopt ethics in its curriculum sometime over the next few years.
We hope that the work outlined in my blogposts, discussed at greater length in my articles, and laid out in our proposed book will be at the forefront of this trend to discuss business ethics and the law. We welcome those reading this blog to be a part of the development of this curriculum for our next generation of business leaders.
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My previous blogposts (one, two, three, four, five, six, seven, and eight) discussed the dangers of granting intracorporate conspiracy immunity to agents who commit coordinated wrongdoing within an organization. The last two blogposts (here and here) highlighted the harm that public and judicial frustration with this immunity inflicts on alternative doctrines.
In addition to exacerbating blind CEO turnover, substituting alternative doctrines for prosecuting intracorporate conspiracy affects an executive’s incentives under Director’s and Officer’s (D&O) liability insurance. This post builds on arguments that I have made about D&O insurance in articles here and here.
In traditional conspiracy prosecutions, the Model Penal Code (MPC) provides an affirmative defense for renunciation. The MPC’s standard protects the actor, who “after conspiring to commit a crime, thwarted the success of the conspiracy, under circumstances manifesting a complete and voluntary renunciation of his criminal purpose.” This means that the executive who renounces an intracorporate conspiracy faces no charges.
In contrast with conspiracy prosecutions, responsible corporate officer doctrine and its correlates fail to reward the executive who changes course to mitigate damages or to abandon further destructive behavior. Although the size of the damages may be smaller with lesser harm if the executive renounces an organization’s course of conduct, the executive’s personal career and reputation may still be destroyed by entry of a judgment. Modest whistle-blower protections are ineffectual.
Specifically, because of the way that indemnification and D&O insurance function, the entry of judgment has become an all-or-nothing standard: an employee’s right to indemnification hinges on whether the employee is found guilty of a crime or not. To receive indemnification under Delaware law, for example, an individual must have been “successful on the merits or otherwise in defense of any action, suit or proceeding.” Indemnification is repayment to the employee from the company; D&O insurance is a method that companies use to pass on the cost of indemnification and may contain different terms than indemnification itself.
Indemnification and D&O insurance are not a minor issues for executives. In fact, under many circumstances, employees have a right to indemnification from an organization even when the alleged conduct is criminal. Courts have acknowleged that “[i]ndemnification encourages corporate service by capable individuals by protecting their personal financial resources from depletion by the expenses they incur during an investigation or litigation that results by reason of that service.” And when hiring for an executive board, “Quality directors will not serve without D&O coverage.” Because of this pressure from executives, as many as ninety-nine percent of public U.S. companies carry D&O insurance.
So what does this standard mean for executives prosecuted under responsible corporate officer doctrine instead of for traditional conspiracy? Executives are incentivized either not to get caught, or to perpetrate a crime large enough that the monetary value of the wrongdoing outweighs the potential damage to the executive’s career. Because an executive’s right to indemnification hinges on whether he is found guilty of a crime or not, he has an enormous incentive to fight charges to the end instead of pleading to a lesser count. Thus, unless the executive has an affirmative defense to charges, like renunciation in traditional conspiracy law, there is no safety valve. Litigating responsible corporate officer doctrine cases creates a new volatile high-wire strategy. Moreover, as discussed in my last blogpost, responsible corporate officer doctrine imposes actual blind “respondeat superior” liability. Regardless of the merits, the executive may be penalized. So you can see the take-home message for executives: go ahead and help yourself to the largest possible slice pie on your way out the door.
I argue that in sending this message, and in many other ways, our current law on corporate crime is badly broken. My last blogpost for the Glom will introduce the book that Lynn Stout and I propose writing to give better direction to business people in search of ethical outcomes.
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My previous blogposts (one, two, three, four, five, six, and seven) discussed why conspiracy prosecutions were the best method to penalize coordinated wrongdoing by agents within an organization. Using alternative doctrines to impose liability on behavior that would otherwise be recognized as an intracorporate conspiracy results in flawed incentives and disproportionate awards.
The fundamental problem with substituting responsible corporate officer doctrine and control person liability for reforming the intracorporate conspiracy doctrine is that these alternative doctrines represent exactly what Professor Martin objects to: actual imposition of blind “respondeat superior” liability. For example, under these doctrines, “in most federal courts, it is not necessary to show that the corporate official being charged had a culpable state of mind.” Instead, the issue before the court is merely whether the officer had control and responsibility for the alleged actions. Accordingly, it is not a defense to control person liability that the officer did not “knowingly participate in or independently commit a violation of the Act.”
But simply penalizing the officer who is in the wrong place at the wrong time does little to define and encourage best practices. Moreover, with these and other explosive hazards for corporate service, it should be no surprise that top executives are demanding and receiving ever-increasing compensation for often short-term positions. Since 2009, the year that the NSP case establishing “control person” liability was settled, the discrepancy in pay between top management and the average worker has been growing dramatically. In 2013, the CEO of J.C. Penny Co., for example, was exposed for making 1,795 times what the average U.S. department store employee made. From 2009 to 2013, as measured across Standard & Poor’s 500 Index (S&P 500) of companies, “the average multiple of CEO compensation to that of rank-and-file workers” has risen to 204, an increase of twenty percent.
It is true that the financial crisis did reduce executive compensation packages before 2009, and that there has been a historical trend towards the growth of executives’ salaries as a multiple of average workers’ salaries. For example, “[es]timates by academics and trade-union groups put the number at 20-to-1 in the 1950s, rising to 42-to-1 in 1980 and 120-to-1 by 2000.” But the jump in executives’ salaries from 2009 has been extraordinary. The new emphasis on vicarious liability for individuals under the responsible corporate officer doctrine since that date must be considered part of executives’ demands for such high compensation in exchange for their risky positions.
The average duration of a CEO’s time in office has diminished as well. In 2000, the average tenure of a departing S&P 500 CEO in the U.S. was ten years. By 2010, it was down to eight years. In 2011, merely a year later, the average tenure of a Fortune 500 CEO was barely 4.6 years. In 2013, that former CEO of J.C. Penny Co. served for only eighteen months.
With an eighteen-month tenure, how much can the chief executive of a large company discover about the wrongdoing that his or her new company is committing? Furthermore, how much can that person design and institute good preventative measures to guide his or her subordinates to avoid that harm? A blindly revolving door for CEOs does not help those interested in effectively reducing the wrongdoing of agents within the corporation. Incentives without intracorporate conspiracy immunity would be different because they would reward the agent who abandons a conspiracy. (More about this argument here, here, here, and here.)
My next blogpost will examine how substituting alternative doctrines for prosecuting intracorporate conspiracy affects incentives under Director’s and Officer’s (D&O) liability insurance.
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My previous blogposts (one, two, three, four, five, and six) discussed why conspiracy prosecutions should be used to reach coordinated wrongdoing by agents within an organization. The intracorporate conspiracy doctrine has distorted agency law and inappropriately handicaps the ability of tort and criminal law to regulate the behavior of organizations and their agents.
My Intracorporate Conspiracy Trap article argues that the intracorporate conspiracy doctrine is not properly based in agency law, and that it should most certainly not be applied throughout tort law and criminal law. As a result of the immunity granted by the doctrine, harmful behavior is ordered and performed without consequences, and the victims of the behavior suffer without appropriate remedy. My Corporate Conspiracy Vacuum article argues that public and judicial frustration with the lack of accountability for corporate conspiracy has now warped the doctrines around it.
Courts have used a wide variety of doctrines to hold agents of enterprises responsible for their actions that should have prosecuted as intracorporate conspiracy. Some of these doctrines include:
But the new applications of these alternative doctrines are producing distortions that make the doctrines less stable, less predictable, and less able to signal proper incentives to individuals within organizations.
An example of how piercing the corporate veil has been used to defeat intracorporate conspiracy immunity can be seen in the Morelia case. A previous blogpost discussed how the intracorporate conspiracy doctrine has defanged RICO prosecutions of agents and business entities. In Morelia, which was a civil RICO case, the federal district court, obviously outraged by defendants’ behavior in the case, explicitly permitted plaintiffs to pierce the corporate veil to avoid application of the intracorporate conspiracy doctrine. In a creative twist invented from whole cloth to link the two doctrines, the Morelia court overruled its magistrate judge’s recommendation to announce:
"Since the court has determined that plaintiffs have properly alleged that the corporate veil should be pierced, the individual defendants may be liable for corporate actions and any distinction created by the intra-corporate doctrine does not exist."
Regarding its test for piercing the corporate veil, the Morelia court further overruled its magistrate’s recommendation by focusing on plaintiffs’ arguments regarding undercapitalization, and its decision included only a single footnote about the disregard of corporate formalities.
The Morelia court is not alone in its frustration with the intracorporate conspiracy doctrine and in its attempt to link analysis under the intracorporate conspiracy doctrine with the stronger equitable tenets of piercing the corporate veil. More subtly, courts across the country have started to entangle the two doctrines’ requirements as intracorporate conspiracy immunity has become stronger and courts have increasingly had to rely on piercing the corporate veil as an ill-fitting alternative to permit conspiracy claims to proceed. Even large public companies should take note. No public company has ever been pierced, but a bankruptcy court recently reverse-pierced corporate veils of the Roman Catholic Church, which is far from a single-person “sham” corporation. My Corporate Conspiracy Vacuum article discusses additional examples and repercussions for incentives under each of these alternative doctrines.
My next blogpost will examine how frustration with intracorporate conspiracy immunity has led to volatility in responsible corporate officer doctrine and related control person liability. Ironically, executive immunity from conspiracy charges fuels counterproductive CEO turnover.
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My previous blogposts (one, two, three, four, and five) introduced why conspiracy prosecutions should be used to reach wrongdoing by agents within an organization. The 2012 prosecution of Monsignor Lynn for twelve years of transferring predator priests from parish to parish at the command and for the benefit of the Archdiocese of Philadelphia was defeated by the intracorporate conspiracy doctrine. Moreover, this was not the first time that the Roman Catholic Church had used the doctrine to help its bureaucrats escape liability for suppressing sex abuse cases.
In 1997, employees of the Roman Catholic Church in Connecticut were alleged—very much like Lynn—to have covered up the sexual misconduct of a priest, enabling him to continue to abuse children entrusted to the Church’s care by virtue of his office. When sued for civil conspiracy by the victims, the employees’ defense was that they were acting in the best interest of the corporation.
The Connecticut court found that the test for whether an agent is acting within the scope of his duties “is not the wrongful nature of the conspirators’ action but whether the wrongful conduct was performed within the scope of the conspirators’ official duties.” If the wrongful conduct was performed within the scope of the conspirators’ official duties, the effect of applying the intracorporate conspiracy doctrine is to find that there was no conspiracy. Because covering up the priest’s sex abuse was in the best interest of the corporate organization, the court found that the employees were all acting on behalf of the corporation. The court never reached the issue of whether the employees’ actions rose to the level of a civil conspiracy. Under the intracorporate conspiracy doctrine, it was a tautology that no conspiracy could be possible.
This case is interesting not only because it documents the way that the intracorporate conspiracy doctrine protects enterprises from inquiry into conspiracies, but also because of the subsequent history of its allegations. The full extent of the Bridgeport Diocese’s wrongdoings—if current public knowledge is indeed complete—only came to light in December 2009, twelve years after the 1997 case. It took twelve years, the combined resources of four major newspapers, an act displaying public condemnation of the Roman Catholic Church by members of the state legislature, and finally a decision by the U.S. Supreme Court to release the documents that could have become the basis of the intracorporate conspiracy claim in 1997. There is still no conspiracy suit or any criminal charge against the Diocese. Additional details about the case are available in my article The Intracorporate Conspiracy Trap. The article will be published soon in the Cardozo Law Review, and it is available in draft form here.
Astonishingly, none of the extensive news coverage about the sexual abuse cases in Bridgeport over those additional twelve years has connected these facts to the original 1997 case defeated by application of the intracorporate conspiracy doctrine. If the intracorporate conspiracy doctrine had not provided immunity, the case might have revealed the Diocese’s pattern of wrongdoing long beforehand and in a much more efficient way.
My next blogpost reveals additional dangers from the spread of the intracorporate conspiracy doctrine: frustration with the intracorporate conspiracy doctrine has started to distort other areas of law.
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My previous blogposts (one, two, three, and four) introduced why conspiracy prosecutions should be used to reach wrongdoing by agents within a business organization. The same legal analysis applies to religious organizations.
We should have been able to charge Monsignor Lynn and the Archdiocese of Philadelphia that directed his actions to hide the sexual abuse by priests with criminal conspiracy. Instead, Pennsylvania charged Lynn with two things: child endangerment and conspiracy with the priests.
As international news outlets later reported, Lynn could not be guilty of child endangerment because the state’s statute could not apply to an administrative church official who did not directly supervise children.
Lynn could not be guilty of conspiracy with the priests because he did not share their “particular criminal intent.” As the jury understood, Lynn was not trying to help a predator priest get from parish to parish so that “he can continue to enjoy what he likes to do.” Lynn was trying to protect the reputation of his employer, the Archdiocese—if the priests benefitted, that was a side issue.
So why didn’t the prosecution charge Lynn and the Archdiocese with conspiracy? It was the Archdiocese that directly coordinated and profited from Lynn’s actions. The intracorporate conspiracy doctrine, as discussed before, would bar that prosecution. In Pennsylvania, it is “well-settled that a corporation cannot conspire with its subsidiary, its agents, or its employees.”
Finally, considering other options, Lynn could not have been charged with possible crimes such as obstruction of justice. Lynn was too good: Lynn and the Archdiocese were so successful at covering up the sexual abuse and silencing victims, there was no ongoing investigation to obstruct. “Aiding and abetting” the Archdiocese’s cover-up of the sex abuse would have been difficult to pursue (see more here) and is not allowed under RICO in the Third Circuit.
My next blogpost will demonstrate that the Monsignor Lynn case was also part of a pattern by the Roman Catholic Church in America to use the intracorporate conspiracy doctrine to hide the coordinated wrongdoing of its agents to cover-up sexual abuse by priests. Fifteen years before prosecutors attempted to try Monsignor Lynn, the silenced Connecticut sex-abuse case showed the Church how effective this defense could be.
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My previous blogposts (one, two, and three) introduced the topic of how the intracorporate conspiracy doctrine prevents the prosecution of coordinated wrongdoing by individuals within organizations. This post illustrates the doctrine’s effect in the context of a specific organization—here a religious one: the Roman Catholic Archdiocese of Philadelphia and the systematic transfer of predator priests. This post is based on my article The Intracorporate Conspiracy Trap to be published soon in the Cardozo Law Review. The article is available in draft form here.
For twelve years, from 1992 to 2004, as Secretary for Clergy, Monsignor William Lynn’s job within the Philadelphia Archdiocese was to supervise priests, including the investigation of sex-abuse claims. In 1994, Monsignor Lynn compiled a list of thirty-five “predator” priests within the archdiocese. He compiled the list from secret church files containing hundreds of child sex-abuse complaints. On the stand, Lynn testified that he hoped that the list would help his superiors to address the growing sex-abuse crisis within the Archdiocese. But for twelve years Lynn merely re-assigned suspected priests, and he hid the abuse within the church. His superiors never acted on the list that Lynn gave them—in fact, they ordered all copies of the list destroyed—and Lynn never contacted outside authorities. As late as 2012, one of the “predator” priests on Lynn’s list was still serving in a parish.
All parties agree that Lynn’s actions in transferring priests who molested children allowed those priests to continue to abuse children, sheltered the priests from potential prosecution, and directly protected the Philadelphia Archdiocese’s reputation.
In fact, Lynn’s actions had been ordered by the archbishop on behalf of the Archdiocese. Lynn reported what he was doing to his superiors, who rewarded Lynn with twelve years of employment and a prominent position within the Archdiocese for doing his job as they saw it. Moreover, the archbishop himself inadvertently revealed the existence of the number thirty-five “predator” priests to the media, and he was the one who ordered all copies of the list to be shredded to keep it from being discovered in legal proceedings.
The instinct here is that this behavior—the transferring of predator priests to cover-up the sexual abuse of children—should have been illegal for Monsignor Lynn to pursue. But the Commonwealth could not prosecute Monsignor Lynn and the Archdiocese for conspiracy. Furthermore, immunity for Lynn’s behavior is now the rule in most state and federal jurisdictions around the country. As described in an earlier blogpost, the intracorporate conspiracy doctrine provides immunity to an enterprise and its agents from conspiracy prosecution, based on the legal fiction that an enterprise and its agents are a single actor incapable of the meeting of two minds to form a conspiracy.
My next blogpost will further investigate why this behavior was not illegal under our current system, and how we should have tried Monsignor Lynn.
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My first and second blogposts introduced why conspiracy prosecutions are particularly important for reaching the coordinated actions of individuals when the elements of wrong-doing may be delegated among members of the group.
So where are the prosecutions for corporate conspiracy??? The Racketeer Influenced and Corrupt Organizations Act of 1970 (“RICO”, 18 U.S.C.A. §§ 1961 et seq.), no longer applies to most business organizations and their employees. In fact, business organizations working together with outside agents can form new protected “enterprises.”
What’s going on here? In this area and many other parts of the law, we are witnessing the power of the intracorporate conspiracy doctrine. This doctrine provides immunity to an enterprise and its agents from conspiracy prosecution, based on the legal fiction that an enterprise and its agents are a single actor incapable of the meeting of two minds to form a conspiracy. According to the most recent American Law Reports survey, the doctrine “applies to corporations generally, including religious corporations and municipal corporations and other governmental bodies. The doctrine applies to all levels of corporate employees, including a corporation’s officers and directors and owners who are individuals.” Moreover, it now extends from antitrust throughout tort and criminal law.
What is the practical effect of this doctrine? The intracorporate conspiracy doctrine has distorted agency law and inappropriately handicaps the ability of tort and criminal law to regulate the behavior of organizations and their agents. Obedience to a principal (up to a point) should be rewarded in agency law. But the law should not immunize an agent who acts in the best interest of her employer to commit wrongdoing. Not only does the intracorporate conspiracy doctrine immunize such wrongdoing, but the more closely that an employer orders and supervises the employee’s illegal acts, the more the employer is protected from prosecution as well.
My next blogpost illustrates how the intracorporate conspiracy doctrine operates to defeat prosecutions for coordinated wrongdoing by agents within an organization. Let’s examine the case of Monsignor Lynn.
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In my previous blogpost, I granted the merit of defense counsel’s argument that the actions of discrete individual defendants—when the law is not permitted to consider the coordination of those actions—may not satisfy the elements of a prosecutable crime.
But what is the coordination of individuals for a wrongful common purpose? That’s a conspiracy. And, for exactly the reasons that defense counsel articulates, these types of crimes cannot be reached by other forms of prosecution. The U.S. Supreme Court has recognized that conspiracy is its own animal. “[C]ollective criminal agreement—partnership in crime—presents a greater potential threat to the public than individual delicts.” When we consider the degree of coordination necessary to create the financial crisis, we are not talking about a single-defendant mugging in a back alley—we are talking about at least the multi-defendant sophistication of a bank robbery.
Conspiracy prosecutions for the financial crisis have some other important features. First, the statute of limitations would run from the last action of a member of the group, not the first action as would be typical of other prosecutions. This means that many crimes from the financial crisis could still be prosecuted (answering Judge Rakoff’s concern). Second, until whistle-blower protections are improved to the point that employees with conscientious objections to processes can be heard, traditional conspiracy law provides an affirmative defense to individuals who renounce the group conspiracy. By contrast, the lesson Wall Street seems to have learned from the J.P. Morgan case is not to allow employees to put objections into writing. Third, counter to objections that conspiracy prosecutions may be too similar to vicarious liability, prosecutors would have to prove that each member of the conspiracy did share the same common intent to commit wrongdoing. The employee shaking his head “no” while saying yes would not be a willing participant, but many other bankers were freely motivated by profit at the expense of client interest to cooperate with a bank’s program.
My next blogpost will ask: where are the prosecutions for corporate conspiracy?
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