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And The Apple Goes To …

Richard Morvillo recently penned this [1] spot-on Law360 article titled “Devaluing the Currency of Settlements.”

In the article, the veteran lawyer asks whether white-collar settlement amounts have increased just because, opines that the DOJ and SEC have cheapened deterrence, raises questions about the lack of individual prosecutions and how this contributes to a facade of enforcement, and discusses how the role of defense counsel has morphed in regulatory investigations.

In pertinent part, Morvillo states:

“Now that the Arthur Andersen debacle is a distant memory, financial and other institutions are begrudgingly accepting guilty pleas and deferred prosecution agreements (“DPAs”). Penalties and fines in the hundreds of millions of dollars that must be borne by existing shareholders, many of whom were not stakeholders at the time of the alleged violations, are also more common. In addition, there is continuing concern within the defense bar that the DOJ is criminalizing conduct that historically was considered to be the grist of civil prosecutions. Similarly, the SEC now appears to be willing to bring more marginal cases as well as those involving “broken windows” and innocent mistakes.

Deterrence is a laudable goal for the DOJ and the SEC. But, despite the fact that generations of prosecutors have invoked “deterrence” as an excuse for being tougher than their immediate predecessors, there is scant evidence that increasing sanctions has had a marked impact on fraudulent and other misconduct. The sheer number of civil and criminal prosecutions brought over the last several years suggests that increasing penalties into the many tens of millions of dollars prior to that time did not forestall misconduct. If the converse were true, the government would not feel the need to ratchet up penalties.

Admittedly, vigorous enforcement, coupled with Dodd Frank, has contributed to enhanced internal controls and greater scrutiny by internal and outside auditors. These improvements began before the recent increase in sanctions and were driven in large part by companies’ self-interest in improving their culture and compliance regimes. Indeed, many institutions re-evaluate and strengthen controls and procedures, especially when they discover a whole or a lapse in existing functions, without waiting for the government to force such changes. Compliance has come a long way. Still, efforts to prevent and to detect misconduct have more to do with the desire for good corporate governance and avoiding future charges of misconduct than with the increasingly punitive size of sanctions the government has been handing out.

Criminal cases and daunting penalties are fodder for headlines, but they will not eliminate the root cause of serious misconduct — the behavior of a few individuals. For example, history teaches us that, though the DOJ and SEC have made insider trading an enforcement priority for years, there is no dearth in insider trading cases they bring year after year. Those willing to violate the law for personal aggrandizement or other reasons will find a way to do so. No compliance or control system can provide a failsafe against one or a few rogue misfeasors in a large company. Economic crime, fraud and other intentional misconduct will be with us so long as greed, arrogance, ego, poor judgment and other such traits are part of our human chemistry.

Criminal fines that are multiples of what they were in the not-too-distant past are now fairly commonplace, as are other forms of costly relief (e.g., compliance monitors). The same holds true for SEC Enforcement settlements, where tens, if not hundreds, of millions of dollars in penalties have been levied in settlements also requiring entities to disgorge large sums ostensibly reflecting the benefits attributable to the misconduct.

[…]

In other words, in raising the ceiling on settlements, the government is also raising the floor. What sufficed to settle a case only a few years ago is a far cry from the minimum sanction the government will demand today. Though, according to the government, the matters recently resolved criminally or at the high end of the sanctions range involved serious misconduct over a prolonged period of time by multiple actors, cases meeting that description are not new. The government said the same thing about its cases years ago after Enron and even before that following the revelations concerning Drexel Burnham and others. Today’s cases are not substantially different at their core from yesterday’s even while, in the interim, the government notched up the price of settlement several times.

[…]

It is rare for a regulated entity to litigate with its regulator, and the government knows that when it arrives at the negotiating table to discuss a resolution. Government prosecutors also count on the fact that companies are anxious to settle in order to get government investigations behind them. While most prosecutors try to be fair, they generally believe in their cases and demand terms the settling company finds inappropriately costly given its perception of the underlying conduct and available defenses. Company management values certainty and finality above all else, however, and often succumbs to the government’s demands simply to end an investigation. For these and other reasons, the government has the leverage to insist on sanctions that the company’s lawyers may not feel are warranted but at some point feel obliged to accept.

[T] he government’s policy of giving credit for cooperation has caused an evolution in the way cases are developed and settled despite the attendant costs. Over the past 10 years or so, the government has come to expect that entities will cooperate with it by identifying problems deserving scrutiny and delivering the facts the government needs to evaluate the conduct of the entity, its employees who were involved and those who supervised the actors. In an era of self-reporting and internal investigations, the traditional role of defense counsel has morphed often into the role of “fact finder” (for, among others, the government). The relationship between the corporate client and the inside and outside counsel is altered in these instances. For example, counsel conducting an internal investigation finds herself giving Upjohn warnings to employees in order to get facts not with which to defend the company but to share with the government. Where credit for cooperation is highest when approaching the government early and being forthright, a company generally wants to take advantage of the opportunity and set the tone for interactions to come. At the same time, having spent the money to investigate and to blow the whistle on itself, the company sets in motion a dynamic that favors a resolution, one in which cooperation should lead prosecutors to offer a more attractive package (albeit not as attractive as one available in the past). Although few defense lawyers and their clients believe that they are rewarded with benefits commensurate with their cooperation, most are not willing to risk the potential outcome of an investigation in which the company declines to cooperate.

The irony is that, while cooperation with the government is at an all-time high, so are the sanctions visited on cooperators. Because many government prosecutions, especially international cases where information is not always easily obtainable by U.S. authorities, resulted directly from extensive and costly cooperation, the government should ensure that corporations perceive that there is a clear benefit in sharing information. There are examples where the government has not brought certain charges or exempted a cooperator from the kind of monetary sanctions typical in cases involving similar misconduct. Yet, many lawyers find it difficult to explain to their clients why cooperation was worth it when the settlement they negotiated still wound up requiring exceedingly large penalties.

Finally, a more insidious problem that may arise from the devaluation of settlement currency is its potential negative impact on deterrence. As noted, deterrence and appropriate punishment for wrongdoers are important, and so is the stigma of being on the wrong end of such charges. A true criminal enterprise should be put out of business, and criminal prosecutions can help bring that about. Caution is necessary, however. Small companies and those in certain businesses, like investment advisers, are not likely to survive criminal or serious civil fraud charges or large penalties, and death is cruel and unusual punishment for their innocent employees who try to do the right thing. While larger entities are better able to withstand similar charges and hefty penalties (especially as the SEC is appropriately inclined to grant relief from the lifeblood-threatening collateral consequences of settlements), there is still cause for concern. Because we now live in an era where felony convictions of entities, DPAs containing punitive sanctions and huge civil penalties are part of the new norm, society will slowly learn to tolerate, if not become callous to, the emerging state of affairs.

The more cases there are with previously unthinkable sanctions, the more readily people will accept those sanctions as a normal cost of doing business. This cheapens the deterrence value of large penalties. The employee bent on violating the law will be dissuaded, if at all, by the threat of individual prosecution, not greater penalties for his employer. The increase in the nature and price of settlement will not alter the perception that companies can still buy their way out of trouble at their shareholders’ expense. That view has already taken hold — whereas Arthur Andersen did not survive after the charges against it, large institutions are now weathering the storm. The fact that institutions can accept responsibility for crimes and previously unheard of monetary penalties suggests that these settlements cause pain in the short term, but are not an effective deterrent in the long term.

Prosecutors understandably feel the need to be tough on intentional misconduct that harms the public. And they should be. At the same time, they should rely less on the “WOW” settlement factor and moderate their thirst for punitive sanctions whose efficacy as deterrence is questionable at best. Rather, they should focus on relief addressing the cause of the conduct and means of preventing it. The public benefits when companies, instead of paying for headline-grabbing fines, use funds to take remedial actions that increase the likelihood of preventing future misconduct.

However much the government claims it takes a company’s pre-settlement remedial actions into consideration, settling defendants are looking for more concrete evidence that their efforts pay dividends. The government should reward these companies more directly for their remedial actions; if penalties are nevertheless appropriate in particular cases, they should be kept in check and reflect, in quantitative terms, substantial offsets for voluntary improvements in internal controls and processes. That will still allow the government to insist that entities that have not taken needed corrective action expend funds adopting better governance procedures going forward.

There is also a perception among many in the defense bar that, while the penalty may vary, the same kind of costly ancillary relief is sought in certain types of cases whether or not the settling company took appropriate remedial steps. For example, compliance monitors and reviews are sometimes mandated in Foreign Corrupt Practices Act settlements notwithstanding the likelihood that their benefits are marginal where a settling entity took appropriate remedial steps before or during the government’s investigation. In recognition of pre-settlement steps, the government should propose more creative prophylactic relief that ensures adherence to newly improved policies. Reviewing and policing how a company handles them going forward are more apt to deter recidivism than redundant exercises or large fines. Thus, for example, the government might defer imposition of a penalty or other sanctions pending a company report on progress over a few years in the compliance area implicated by the settled charges; the sanctions could be triggered if defined compliance milestones are not met.

Government officials believe that they already adequately fashion resolutions in light of remedial actions taken by the settling defendant. Few in the private sector agree, however, and some think that the recent spate of increased sanctions demonstrates that the government has taken the opposite tack. We can hope that the government stops the seemingly never-ending escalation of sanctions and adopts a more measured approach focused on deterrence and not on headlines and out-sized penalties.”

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