The guilty verdict for Virginia ex-governor Bob McDonnell on charges of public corruption is a major headline of today. I've been thinking a lot about corruption for the past few months, so here are a few thoughts:
-Corruption is in the eye of the beholder. My Essay turns on the proximity of time of two donations and legislative action. In the most notable case, a member of the House introduced a bill the day after receiving a $1000 donation. Readers' reactions to the story fall into two distinct camps. One: OMG! I can't believe that! Two: So what? Why does that necessarily mean there's corruption? In answer I say:
-Timing does matter. From the WaPo:
[Prosecutors] backed up his story by using other evidence to weave a strong circumstantial case that an agreement had been reached between the businessman and the first couple based on the close timing of Williams’s gifts and loans and efforts by the McDonnells to assist Williams and his company.
In one instance, McDonnell directed a subordinate to meet with Williams on the same night he returned from a free vacation at his lake house. In another, six minutes after e-mailing Williams about a loan, McDonnell e-mailed an aide about studies Williams wanted conducted on his product at public universities.
-definitions are the name of the game. The Supreme Court's 2014 McCutcheon decision narrowed the definition of corruption to only cases of quid pro quo corruption--cases where there's an actual exchange. The McDonnell defense apparently conceded that there was an exchange, but contested whether the quo in question--events at the governor's mansion, setting up meetings for the donor--counted as "official acts." This is a broad definition.
-Corporations are always going to participate in political life. We expect them to lobby for positions favorable to their firms. See here for a recent WSJ article on disclosure of political spending, with quotations from some sterling law professors, including friends-of-Glom Mike Guttentag and Steve Bainbridge, who quite rightly observes that the risk is that managers spend the corporation's money "on their own preferences, as opposed to what's good for the company."
-So in corporate governance terms the question is how to sort the "good" spending that is for the benefit of the company from the "bad" spending that is driven by idiosyncratic managerial preference and doesn't do the corporation any good. But in political governance terms, the question is how to regulate even "good" corporate spending that we find to be corrupting. I at least don't have a good idea of how to draw that line. The Court says trading donations for access is fine, and so are donations that secure a candidate's gratitude. My hunch is a lot of people might call those corruption. But corporations need to be able to explain to candidates how the government's rules and regulations affect their business. I'm certainly not confident that the average politician knows much of anything about any particular issue.
So where does that leave me? Still wondering about corruption, and eager to get back to corporate and securities law, that's where!
I wanted to finish up my discussion of administrative enforcement by considering alternatives. We often take regulatory enforcement for granted. A securities regulator, for example, naturally will have the power to seek out violations of the securities laws and sanction violations. As is common in administrative law, scholars, courts, and Congress start with the assumption that expertise in the industry is the most important input into the enforcement calculus. If an agency is familiar with an industry, it will make good enforcement choices.
In my forthcoming article in the Minnesota Law Review, I argue that this question is actually much more complex than we usually assume. In particular, prosecutorial discretion has strong generalist aspects that largely do not depend on the regulatory subject matter. Giving enforcement authority to a specialist agency instead of a generalist enforcer (such as the Department of Justice) trades one type of expertise for another. Furthermore, specialists inherently see enforcement actions more narrowly. As a result, we shouldn’t see enforcement by regulatory agencies as inevitable or automatic.
Since it is still in draft form, I’d very much appreciate any and all comments. Thanks again to Erik for the chance to blog this week.
I blogged yesterday about administrative enforcement, an area that lies at the intersection of criminal and administrative law. Among other topics, my scholarship has considered the civil penalty process. In particular, what are the inputs and incentives that shape administrative agency penalties?
A standard model used to describe the penalty process emphasizes economic theories of deterrence. Financial penalties are a mechanism to raise the price for violations either to make misconduct completely unprofitable or, in the alternative, to force violators to internalize the costs of violations. I’ve pointed out one way that this theory may break down – administrative agencies might not focus on deterrence at all. Instead, their penalties may be crafted to achieve retributive ends.
In our recent Harvard Law Review article, For-Profit Public Enforcement, Margaret H. Lemos and I looked at penalties from another perspective: public enforcers may have self-interested reasons to maximize civil penalty recoveries. These incentives are widely recognized in private enforcement. Class action lawyers, for example, operating on a contingency fee basis have straightforward reasons to maximize recoveries.
Perhaps less obviously, public enforcement lawyers can have comparable incentives to impose large penalties. These incentives work most clearly in cases where enforcement agencies keep a portion of the civil penalties imposed. This structure is common in the asset forfeiture process used in connection with many criminal cases and also exists in other state and federal enforcement contexts. Even when penalties are turned over to the general treasury, enforcers may have reputational incentives to maximize penalties. Both agencies as a whole and individuals working in enforcement agencies may seek to build a reputation as an aggressive enforcer for reasons other than deterrence.
Assuming that these claims are right and that civil penalties can be driven by retributive or self-interested goals, is this a problem? Perhaps, perhaps not. Self-interested public enforcement may push enforcers to emphasize financial recoveries over other tools of regulatory control, such as injunctive relief. However, if our default assumption is that administrative agencies underenforce and usually do not impose adequate penalties, the pressure of self-interest may correct this trend to some degree.
The presence of retribution in civil penalties has similarly mixed effects. Of course, if penalties are supposed to be carefully calculated to deter, retributive ends will hamper this goal. On the other end, we now widely recognize the role of norms in shaping compliance behavior. Retributive punishment done well can shape and reinforce industry norms.
Erik, thank you for that introduction. It is a pleasure to join the Conglomerate for a week. My scholarly interests have recently focused on federal administrative enforcement – enforcement actions by agencies like the SEC, the CFTC, as well as a host of lower profile entities. This is a fascinating area of public law combining two scholarly literatures. Administrative enforcement actions share much in common with criminal cases. They are brought by public entities to vindicate public wrongs. However, the administrative context deeply shapes this type of enforcement. For example, unlike most prosecutor's offices, administrative enforcement bodies tend to be industry-specific.
As a result, administrative enforcement can go wrong in two different ways– the “criminal law” way or the “administrative law” way. Administrative agencies face the challenges of regulatory capture, inadequate or incorrect information, or simply the wrong incentives to engage in appropriate regulatory action. Criminal enforcement, though, often struggles with procedural fairness as well as the difficult task of assigning the correct level of punishment to different forms of misconduct.
Take, for example, this last issue: the fundamental question of penalty levels. Administrative agencies commonly use financial penalties to punish regulatory violations. How should these penalties be set? Which cases require the largest penalties and which only need more modest sanctions?
Criminal law scholars will recognize this question as an inquiry about theories of punishment. Speaking broadly, criminal law considers a couple of approaches. Utilitarian theories of punishment (e.g., deterrence, rehabilitation, incapacitation) seek to punish conduct to produce beneficial social outcomes. Retributive theories emphasize desert – punishment occurs because the violator deserves punishment, not because it produces a social benefit.
So what do federal agencies do? As I argue here, administrative agencies almost uniformly talk about deterrence, but usually engage in retribution. When setting penalty levels, agencies move penalties up or down in response to facts that justify retributive punishment but do not adjust penalties in the way deterrence requires. For instance, building on Gary Becker’s justifiably famous work, Crime and Punishment: An Economic Approach, most deterrence theories emphasize the role of the probability of detection in setting penalty levels. To deter appropriately, penalties need to increase when violations are harder to detect and punish. In practice, though, administrative agencies place little weight on this issue. Instead, agencies are deeply concerned with issues like mens rea, a topic far more central to retributive theories of punishment.
Is this retributive bent in administrative enforcement surprising? Perhaps not. A large literature suggests that most people are intuitively retributive when making punishment choices. In social science experiments, study participants set penalties based on retributive concerns, but do not adjust punishment levels in ways that would be required to deter appropriately. In this way, administrative agencies look like the rest of us. We mostly care about desert even when we talk about deterrence.
The Bitcoin exchange Mt. Gox appeared to be undergoing more convulsions Tuesday [February 25], as its website became unavailable and trading there appeared to have stopped, signaling a new stage in troubles that have dented the image of the virtual currency. . . .
Investors have been unable to withdraw funds from Mt. Gox since the beginning of this month. The exchange has said that a flaw in the bitcoin software allowed transaction records to be altered, potentially making possible fraudulent withdrawals. No allegations have been made of wrongdoing by the exchange, but the potential for theft has raised concern that the exchange wouldn't be able to meet its obligations.
The apparent collapse of Mt. Gox is just the latest shock to hit Bitcoin, the price of which is now off more than 50% from its December 2013 peak:
For those better acquainted with the dead-tree/dead-president variety of money, Bitcoin is a virtual currency not backed by any government. Rather than being printed or minted by a central bank, Bitcoins are created by a computer algorithm in a process known as "mining" and are stored online or on your computer. They are bought and sold on various exchanges, including until recently Mt. Gox (whose troubles have been reported for a few weeks now).
There are many reasons, some of them even lawful. Bitcoins can be regarded as a medium of exchange, an investment, a political statement...or a way of avoiding capital controls and other pesky laws like bans on drug trafficking and human smuggling.
But the criminal potential of Bitcoin is probably overstated. The Chinese have gotten wise to its use for avoiding capital controls. Using Bitcoin for criminal or fraudulent activity would be difficult at scale (PDF). The Walter White method is still far and away the best way to ensure your criminal proceeds retain their value and anonymity.
I don't share the utopian fervor for Bitcoin expressed in tech and libertarian circles (see, e.g., this supposedly non-utopian cri de coeur), but it may have some positive potential as a decentralized and lower-cost electronic payments system. We'll see if that ever gets off the ground.
In the meantime, the Mt. Gox collapse is pretty huge news for Bitcoinland. Unlike the NYSE (the failure of which would be hard even to imagine), Mt. Gox does not benefit from any systemic significance and thus is unlikely to receive a lot of official-sector help. The situation has some early adopters running for the Bitcoin exits, like this leading Bitcoin evangelist.
Despite (because of?) my agnosticism on the currency, I'll be writing more about Bitcoin soon. (Mainly, I wanted to stake a claim to being the first to write about Bitcoin on The Conglomerate.) If your Palo Alto cocktail party can't wait, however, this explainer (PDF) from the ever-impressive Chicago Fed should tide you over.
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The prosecution is alleging some very interesting facts regarding Matthew Martoma’s past as a student at Harvard Law School. According an ABA Journal story, Prosecutors contend that Martoma was expelled from Harvard in 1999 after forging transcripts for judicial clerkship applications. According to prosecutors, Martoma submitted a forensic report to a Harvard disciplinary committee without disclosing that he founded the company that prepared that report. Martoma had a soft landing after Harvard – graduating with an MBA from Stanford and ultimately moving to SAC.
Beyond the evidentiary issues, if these allegations in the Martoma trial are confirmed, they should give law professors some pause. Student disciplinary matters are always gut-wrenching. Faculty members often hope that students can learn from mistakes. But students may be a lot more fully formed than we think by the time they enter law school. In the wake of every wave of scandals, there is always handwringing about the need for more ethics training both in law and business schools. There is an increased need for more empirical study of the effects of ethics courses and various approaches to teaching ethics. Just as we can’t extrapolate from a sample size of one, we also need to be fairly hardnosed about evaluating what does and doesn’t shape professional conduct.
Here are a few gift suggestions culled from books published this year if your special someone is a lawyer who associates Modigliani and Miller with capital structure and not paintings with elongated faces and the Tropic of Cancer:
- Tamar Frankel’s The Ponzi Scheme Puzzle;
- Steve Bainbridge’s Corporate Governance after the Financial Crisis (for a point of comparison, see his former colleague Lynn Stout’s The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public);
- Research Handbook on the Economics of Corporate Law, a collection edited by Claire Hill & Brett McDonnell.
Even the non-lawyers and non-academics in your life might enjoy Frank Partnoy’s Wait: The Art and Science of Delay. Of course, the target audience might never get around to buying the book.
Players and coaches from the New Orleans Saints created a system of "bounty" payments for injuring opposing players severely enough to get them removed from the game. According to ESPN:
Payments were made for plays such as interceptions and fumble recoveries. But the program also included "bounty" payments for "cart-offs," meaning that the opposing player was carried off the field, and "knockouts," meaning that the opposing player was not able to return.
Instead of talking about "putting this behind us and winning more championships in the future for our fans," shouldn't Saints owner Tom Benson be talking about getting criminal defense lawyers for his players and coaches?
Thanks to Erik Gerding for the opportunity to share some of my ideas on corporate criminal liability, Dodd-Frank, corporate influences on individual behavior and educating today's law students only three months into my new academic career. I appreciate the thoughtful and encouraging emails I received from many of you. I even received a request for an interview from the Wall Street Journal after a reporter read my two blog posts on Dodd-Frank conflicts minerals governance disclosures. We had a lengthy conversation and although I only had one quote, he did link to the Conglomerate posts and for that I am very grateful.
I plan to make this site required reading for my seminar students, and look forward to continuing to learn from you all.
Best wishes for the holiday season and new year.
Time Magazine’s “person of the year” is the “protestor.” Occupy Wall Street’s participants have generated discussion unprecedented in recent years about the role of corporations and their executives in society. The movement has influenced workers and unemployed alike around the world and has clearly shaped the political debate.
But how does a corporation really act? Doesn’t it act through its people? And do those people behave like the members of the homo economicus species acting rationally, selfishly for their greatest material advantage and without consideration about morality, ethics or other people? If so, can a corporation really have a conscience?
In her book Cultivating Conscience: How Good Laws Make Good People, Lynn Stout, a corporate and securities professor at UCLA School of Law argues that the homo economicus model does a poor job of predicting behavior within corporations. Stout takes aim at Oliver Wendell Holmes’ theory of the “bad man” (which forms the basis of homo economicus), Hobbes’ approach in Leviathan, John Stuart Mill’s theory of political economy, and those judges, law professors, regulators and policymakers who focus solely on the law and economics theory that material incentives are the only things that matter.
Citing hundreds of sociological studies that have been replicated around the world over the past fifty years, evolutionary biology, and experimental gaming theory, she concludes that people do not generally behave like the “rational maximizers” that ecomonic theory would predict. In fact other than the 1-3% of the population who are psychopaths, people are “prosocial, ” meaning that they sacrifice to follow ethical rules, or to help or avoid harming others (although interestingly in student studies, economics majors tended to be less prosocial than others).
She recommends a three-factor model for judges, regulators and legislators who want to shape human behavior:
“Unselfish prosocial behavior toward strangers, including unselfish compliance with legal and ethical rules, is triggered by social context, including especially:
(1) instructions from authority
(2) beliefs about others’ prosocial behavior; and
(3) the magnitude of the benefits to others.
Prosocial behavior declines, however, as the personal cost of acting prosocially increases.”
While she focuses on tort, contract and criminal law, her model and criticisms of the homo economicus model may be particularly helpful in the context of understanding corporate behavior. Corporations clearly influence how their people act. Professor Pamela Bucy, for example, argues that government should only be able to convict a corporation if it proves that the corporate ethos encouraged agents of the corporation to commit the criminal act. That corporate ethos results from individuals working together toward corporate goals.
Stout observes that an entire generation of business and political leaders has been taught that people only respond to material incentives, which leads to poor planning that can have devastating results by steering naturally prosocial people to toward unethical or illegal behavior. She warns against “rais[ing] the cost of conscience,” stating that “if we want people to be good, we must not tempt them to be bad.”
In her forthcoming article “Killing Conscience: The Unintended Behavioral Consequences of ‘Pay for Performance,’” she applies behavioral science to incentive based-pay. She points to the savings and loans crisis of the 80's, the recent teacher cheating scandals on standardized tests, Enron, Worldcom, the 2008 credit crisis, which stemmed in part from performance-based bonuses that tempted brokers to approve risky loans, and Bear Sterns and AIG executives who bet on risky derivatives. She disagrees with those who say that that those incentive plans were poorly designed, arguing instead that excessive reliance on even well designed ex-ante incentive plans can “snuff out” or suppress conscience and create “psycopathogenic” environments, and has done so as evidenced by “a disturbing outbreak of executive-driven corporate frauds, scandals and failures.” She further notes that the pay for performance movement has produced less than stellar improvement in the performance and profitability of most US companies.
She advocates instead for trust-based” compensation arrangements, which take into account the parties’ capacity for prosocial behavior rather than leading employees to believe that the employer rewards selfish behavior. This is especially true if that reward tempts employees to engage in fraudulent or opportunistic behavior if that is the only way to realistically achieve the performance metric.
Applying her three factor model looks like this: Does the company’s messaging tell employees that it doesn’t care about ethics? Is it rewarding other people to act in the same way? And is it signaling that there is nothing wrong with unethical behavior or that there are no victims? This theory fits in nicely with the Bucy corporate ethos paradigm described above.
Stout proposes modest, nonmaterial rewards such as greater job responsibilities, public recognition, and more reasonable cash awards based upon subjective, ex post evaluations on the employee’s performance, and cites studies indicating that most employees thrive and are more creative in environments that don’t focus on ex ante monetary incentives. She yearns for the pre 162(m) days when the tax code didn’t require corporations to tie executive pay over one million dollars to performance metrics.
Stout’s application of these behavioral science theories provide guidance that lawmakers and others may want to consider as they look at legislation to prevent or at least mitigate the next corporate scandal. She also provides food for thought for those in corporate America who want to change the dynamics and trust factors within their organizations, and by extension their employee base, shareholders and the general population.
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Massey Energy and Walmart made headlines last week for different reasons. Massey had the worst mining disaster in 40 years, killing 29 employees and entered into a nonprescution agreement with the Department of Justice. The DOJ has stated in the past that these agreements balance the interests of penalizing offending companies, compensating victims and stopping criminal conduct “without the loss of jobs, the loss of pensions, and other significant negative consequences to innocent parties who played no role in the criminal conduct, were unaware of it, or were unable to prevent it.”
Massey’s new owner Alpha Natural Resources, has agreed to pay $210 million dollars in fines to the government, compensation to the families of the deceased miners and for safety improvements (the latter may be tax-deductible). The government’s 972-page report concluded that the root cause was Massey’s “systematic, intentional and aggressive efforts” to conceal life threatening safety violations. The company maintained a doctored set of safety records for investigators, intimidated workers who complained of safety issues, warned miners when inspectors were coming (a crime), and had 370 violations. The mine had been shut down 48 times in the previous year and reopened once violations were fixed. 112 miners had had no basic safety training at all. Only one executive has been convicted of destroying documents and obstruction, and investigations on other executives are pending. However, the company itself has escaped prosecution for violations of the Mine Safety and Health Act, conspiracy or obstruction of justice. Perhaps new ownership swayed prosecutors and if Massey had its same owners, things would be different. But is this really justice? The miner’s families receiving the settlement certainly don’t think so.
Walmart announced in its 10-Q that based upon a compliance review and other sources (Dodd-Frank whistleblowers maybe?), it had informed both the SEC and DOJ that it was conducting a worldwide review of its practices to ensure that there were no violations of the Foreign Corrupt Practices Act (“FCPA”). Although no facts have come out in the Walmart case and I have no personal knowledge of the circumstances, let’s assume for the sake of this post that Walmart has a robust compliance program, which takes a risk based approach to training its two million employees in what they need to know (the greeter in Tulsa may not need in-depth training on bribery and corruption but the warehouse manager and office workers in Brazil and China do). Let’s also assume that Walmart can hire the best attorneys, investigators and consultants around, and based on their advice, chose to disclose to the government that they were conducting an internal investigation. Let’s further assume that the incidents are not widespread and may involve a few rogue managers around the world, who have chosen to ignore the training and the policies and a strong tone at the top.
As is common today, let’s also assume that depending on what they find, the company will do what every good “corporate citizen” does to avoid indictment --disclose all factual findings and underlying information of its internal investigation, waive the attorney client privilege and work product protection, fire employees, replace management, possibly cut off payment of legal fees for those under investigation, and actively participate in any government investigations of employees, competitors, agents and vendors.
Should this idealized version of Walmart be treated the same as Massey Energy? (For a great compilation of essays on the potential conflicts between the company and its employees, read Prosecutors in the Boardroom: Using Criminal Law to Regulate Corporate Conduct, edited by Anthony and Rachel Barkow). Should they both be charged and face trial or should they get deferred or nonprosecution agreements for cooperation? Do these NPAs and DPAs erode our sense of justice or should there be an additional alternative for companies that have done the right thing -- an affirmative defense?
A discussion of the history of corporate criminal liability would be too detailed for this post, but in its most simplistic form, ever since the 1909 case of New York Central & Hudson River Railroad Co v. United States, companies have endured strict liability for the criminal acts of employees who were acting within the scope of their employment and who were motivated in part by an intent to benefit the corporation. As case law has evolved, companies face this liability even if the employee flouted clear rules and mandates and the company has a state of the art compliance program and corporate culture. In reality, no matter how much money, time or effort a company spends to train and inculcate values into its employees, agents and vendors, there is no guarantee that their employees will neither intentionally nor unintentionally violate the law.
The DOJ has reiterated this 1909 standard in its policy documents. And because so few corporations go to trial and instead enter into DPAs or NPAs, we don’t know whether the compliance programs in place would have led to either the potential 400% increase or 95% decrease in fines and penalties under the Federal Sentencing Guidelines because judges aren’t making those determinations. The DPAs are now providing more information about corporate compliance reporting provisions, but again, even if a company already had all of those practices in place, and a rogue group of employees ignored them, the company faces the criminal liability. The Ethical Resource Center is preparing a report in celebration of the 20th Anniversary of the Sentencing Guidelines with recommendations for the U.S. Sentencing Commission, members of Congress, the DOJ and other enforcement agencies. They are excellent and timely, but they do not go far enough.
A Massey Energy should not receive the same treatment as my idealized model corporate citizen Walmart. Instead, I agree with Larry Thompson, formerly of the DOJ and now a general counsel and others who propose an affirmative defense for an effective compliance program- not simply as possible reduction in a fine or a DPA or NPA.
While the ideal standard would require prosecutors to prove that upper management was willfully blind or negligent regarding the conduct, this proposed standard may presume corporate involvement or condonation of wrongful conduct but allow the company to rebut this presumption with a defense.
In the past decade, companies drastically changed their antiharassment programs after the Supreme Court cases of Fargher and Ellerth allowed for an affirmative defense. The UK Bribery Act also allows for an affirmative defense for implementing “adequate procedures” with six principles of bribery prevention. Interestingly, they too are looking at instituting DPAs.
I would limit a proposed affirmative defense to when nonpolicymaking employees have committed misconduct contrary to law, policy or management instructions. If the company adopted or ratified the conduct and/or did not correct it, it could not avail itself of the defense. The company would have to prove by a preponderance of the evidence that: it has implemented a state of the art program approved and overseen by the board or a designated committee; clearly communicated the corporation’s intent to comply with the law and announced employee penalties for prohibited acts; met or exceeded industry standards and norms; is periodically audited and benchmarked by a third party and has made modifications if necessary; has financial incentives for lawful and penalties unlawful behavior; elevated the compliance officer to report directly to the board or a designated committee (a suggestion rejected in the 2010 amendments to the Sentencing Guidelines); has consistently applied anti-retaliation policies for whistleblowers; voluntarily reported wrongdoing to authorities when appropriate; and of course taken into account what the DOJ has required of offending companies and which is now becoming the standard. The court should have to rule on the defense pre-trial.
Instead of serving as vicarious or deputized prosecutors, under this proposed standard, a corporation’s cooperation with prosecutors will be based on factors more within the corporation's control,rather than the catch-22 they currently face where if employees are guilty, there is no defense. And if the employees are guilty, this would not preclude the government from prosecuting them, as they should.
Responsible corporations now spend significant sums on compliance programs and the reward is simply a reduction in a fine for conduct for which it is vicariously liable and which its policies strictly prohibited. A defense will promote earlier detection and remedying of the wrongdoing, reduce government expenditures, provide more assurance to investors and regulators, allow the government to focus on companies that don’t have effective compliance program, and most important provide incentives for companies to invest in more state of the art programs rather than a cosmetic, check the box initiative because the standard would be higher than what is currently Sentencing Guidelines.
Perhaps only a small number of companies may be able to prevail with this defense. Frankly, corporations won’t want to bear the risk of a trial, but they will at least have a better negotiating position with prosecutors. Moreover, companies that try in good faith to do the right thing won’t be lumped into the same categories as those who invest in the least expensive programs that may pass muster or worse, engage in clearly intentional criminal behavior. If companies have the certainty that there is a chance to use a defense, that will invariably lead to stronger programs that can truly detect and prevent criminal behavior.
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Yesterday’s Wall Street Journal ran a story (password required) on federal prosecutors using the “responsible corporate officer” doctrine to impose personal liability on the officers and directors of drug companies for violations of food & drug laws.
This revives an obscure doctrine that I wrote about a few years ago (see here, pages 313-318) for a book that compared director liability for corporate actions across countries. The responsible corporate officer is understandably extremely worrying for corporate boards and executives because it means civil and even criminal liability when a corporation violates a law absent a director or officer knowing about the violation.
It is important to note that the scope of the doctrine is limited. It sprang forth in the 1943 Supreme Court case U.S. v. Dotterweich which interpreted the Federal Food, Drug and Cosmetic Act. The Court upheld the application of the doctrine to the same statute in 1975 in U.S. v. Park. In the 2003 case Meyer v. Holley, the Court revisited the doctrine and stated that Congress must be fairly explicit in a statute that it intends the doctrine to apply. And the current Supreme Court is unlikely to reverse course on this. The responsible corporate officer doctrine is unlikely to apply to new statutes absent explicit Congressional language.
Even so, the doctrine does apply to more than one federal food & drug statute. I list a number of federal cases in that book chapter I mention above. Moreover, state legislatures and courts have also applied the statute to state laws (and Meyer v. Holley does not necessarily constrain the ability of state courts to apply the doctrine to state statutes more liberally). So this dormant doctrinal strain should only give pause to boards and executives in certain heavily regulated industries that are subject to certain statutes. The doctrine is more limited, but potentially vastly more powerful – because lack of knowledge is not a defense -- than other sources of liability for directors that have been much more analyzed in recent years (for example, securities laws and Disney/Caremark/Stone v. Ritter).
I'm supposed to be devoting my summer to thinking about things like microfinance and securitization, but the past month I've been thinking at odd moments about two cases that have been capturing a lot of media attention: the prosecution of Casey Anthony for the murder of her 2 year-old daughter, Caylee, and the almost-prosecution of Dominique Strauss-Kahn for the sexual attack on a housekeeper at a NY hotel. Anthony was acquitted by a jury yesterday in the face of fairly thin evidence, notwithstanding her many admitted lies and inconsistencies. DSK seems to be about to avoid prosecution though he was indicted for sexual assault earlier. These cases are politically and socio-economically fairly far apart: the defendant in one was an unwed mother at age 19 while the other is a 60-ish Frenchman who headed up the IMF. But the cases have at least one thing in common: the person at the center of both is a liar.
Prosecutors have a lot of discretion over whether to bring criminal actions against defendants and to choose the charges. I have nothing to add to the voluminous legal literature on this. In the Anthony case, prosecutors no doubt felt pressure to indict someone in a case involving the dead body of a cute toddler. But, they probably felt more confident than they should have considering the lack of physical evidence based on the fact that Anthony is a liar. And a horrible one. She lied to investigators about almost everything but her name. Conventional wisdom says that juries hate liars. And all of the U.S. hates Casey Anthony, so why not go ahead and prosecute? But Anthony won, even though she lied at every turn and could provide no evidence of her defense -- that Caylee accidentally drowned but that Anthony covered up the drowning with the help of Casey's dad, who made her into a pathological liar by sexually abusing her. The judge even ruled that the alleged sexual abuse couldn't be mentioned in closing because no evidence backed it up. Many are outraged by the verdict, but one can argue that the rule of law prevailed. Regardless of what you think in your gut, we try not to sentence defendants to death based on the fact that they are crappy parents, get tattoos, have used cars that smell "like death" or tell lies.
So then what does Anthony's verdict tell us about the DSK case? Maybe that we can trust juries to understand that just because people lie, that doesn't mean that they should be tossed around by the legal system. To catch up, DSK's unnamed accuser has told some lies in the past: on her asylum application (from Guinea) and on her IRS tax returns. She has also changed her story: first, she told a supervisor about the attack immediately, now she says she cleaned another hotel room then finished DSK's before contacting a supervisor. It also may be that her boyfriend is a drug dealer and uses her bank accounts as part of his business dealings. They may also be trying to make lemonade out of lemons with this case against a wealthy defendant. But, just as Anthony's lies don't necessarily add up to her murdering Caylee, the accuser's lies here don't necessarily mean than she was not assaulted.
Anthony may tell lies out of mental illness, or she may just tell lies recklessly to avoid punishment either for covering up her child's accidental death or for a larger role in the child's death. She blamed Caylee's disappearance on two people who don't exist, and at the last minute blamed her father for atrocious acts. If Caylee was lying about her father, then that has to be one of the worst lies imaginable. DSK's accuser tells lies not to escape punishment, but to escape a dangerous existence in Guinea. (Here is a great op-ed about the accuser's motivations to lie.) You don't have to be Victor Hugo to realize that sometimes good people commit small infractions to save the lives of their family and themselves. Most of us in the U.S. have absolutely no idea what we would die to escape across the ocean so we and our children won't be raped or killed. Lying or exaggerating to gain asylum is probably the least morally questionable of the choices we might make. Surely if the Anthony jury could see past her lies to look at the evidence, a jury in a DSK case could look past the accuser's lies to judge the evidence. Anyway, just some random thoughts from a crazy month of looking at the CNN website!
The last two weeks have witnessed dramatic victories against two very different lawbreaking networks. First the death of Bin Laden removed the leader of al Qaeda. Second, the conviction of Raj Rajaratnam represented a major victory for prosecutors against the so-called expert insider trading networks. Although the two lawbreaking networks have a multitude of differences – in terms of social harm, motivations, and structure – they also have important similarities.
For one thing, both terror networks and insider trading networks present an opportunity to study social networks in a rigorous manner. “Networks” are more than just loose metaphor, but instead the subject of the emerging field of network theory that borrows from and links computer science, sociology, economics and a host of other fields. “Emerging” does not mean new: some of the germinal research stretches back over four decades. For example Granovetter’s work on “weak ties” in sociology. Mark Lemley and David McGowan authored a wonderful piece on network effects and law over 10 years ago and the legal literature continues to blossom (from Aviram to Zaring). Network theory has arrived.
And it is being put to use. A number of years ago, media reports suggested that the U.S. intelligence agencies were seeking to use network theory to crack Al Qaeda (see here for a law review article by Christopher Borgen on network theory and terrorism). The extent to which financial regulators and prosecutors have done the same with respect to insider trading is not clear, although scholars have recently suggested new potential approaches.
We may not know for a long time the extent to which network theory is influencing law enforcement. You can understand that intelligence and law enforcement would be unwilling to disclose the methods they use to catch bad guys. But the secrecy means that their methods do not enjoy the benefits – one could even say network effects – of being subject to the scrutiny of a larger community. Observers could help answer vital questions, such as “how effective are these efforts against lawbreakers?” and “could they be improved?” According to Linus’s Law: “given enough eyeballs, all bugs are shallow.” Aside from questions about efficacy, there are lingering and legitimate concerns about the implications of national security surveillance over internet communications.
But even the information we have learned about the two recent victories against anti-social networks leads to some interesting, if tentative observations. First, the ultimate value of these government operations is not in traditional deterrence alone, but in disrupting networks. In other words, successful operations against networks rely not only on crude deterrence of criminal behavior by scaring off would-be criminals. After all, it isn’t clear that a jihadist will be sobered by Bin Laden’s fate. By contrast, one thing that does disrupt networks is interfering with their capacity to send signals. Driving bad guys off the net seriously interferes with their ability to conduct business. From news reports, it doesn’t look like Bin Laden was all that successful in managing operations without an internet connection or a phone line. (Some reports suggest that the one time he did use a phone contributed to his location by U.S. intelligence.) Of course, government surveillance is thwarted not only by encryption, but by the daunting task of finding a needle in a haystack of data. Old-fashioned informants will still prove a critical tool.
Indeed media reports suggest that the government is heavily relying on informants in cracking the expert insider trading networks. From the perspective of law enforcement, this is important not only because it may lead to prosecutions, but also because it might disrupt the thing that these networks most rely on: trust.
So network theory suggests that we pay more attention to the marginalia of the Rajaratnam story. It is not the conviction alone that matters. It also argues for looking at other policy tools – such as a use of bounties in corporate crime – in another dimension, namely engendering distrust and thwarting the development of illegal networks. Of course, bounties for corporate crime and promoting snitching can create their own perverse incentives and pernicious effects. (Eleanor Brown penned an interesting essay on snitching, immigration, and terrorism that uses network theory.)
Another problem with a broader use of these tools is that they don’t always yield headline grabbing successes. No one sees the insider trading or terror attacks or law breaking that didn’t happen. The political economy of deterrence rewards prosecutors for victories in the courtroom, not necessarily for crime prevented.
Still, the events of the last week should give new life to study of network theory. There is evidence that network theory has become white hot. Consider this graph (from Google’s nifty Ngram tool) that plots the rising use of “network effect” compared to “deterrence effect” in books from1970 to mid 2007.
One can now also see a lot of those neat network graphs (see below) in news reporting.
Of course, the popularization of theory also threatens to reduce the intellectual rigor. Let’s hope the network effects of this line of inquiry are positive.
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Must have been a responsible jury, listening to all of those wiretaps again and again. Because, despite being out so long that you thought there must be some internal dissension, they came back with Rajaratnam guilty on all counts. A big win for the SEC and DOJ, and something that may mean a lot for the expert networks, which have been a ubiquitous feature of Wall Street edge-getting up until now.