Ethics Resource Center

Published: December 30, 2008

The Policy Report
By Paula J. Desio, ERC Chair on Ethics Policy

Ethics and Compliance Programs May Get Their Day in Court
Will they soon provide a legal defense to criminal liability?

The fate of an obscure Greek shipping corporation, Ionia Management, recently convicted in a U.S. court of dumping oily waste at sea, may well lead to reconsideration of the basic legal tenet of federal corporate criminal liability.

In a “friend of the court” brief filed in the case, a coalition of business and criminal defense associations proposes an increased legal role for effective ethics and compliance programs in defending against, rather than merely mitigating, liability under the U.S.’s rigid legal standards.

Regardless of whether the argument, currently being heard on appeal in New York, has any chance of immediate success and actual implementation in legal proceedings, the policy advanced in the friend of the court brief may be a harbinger of yet another area where committed ethics and compliance efforts will serve corporate citizens well. 

The Current State of Affairs

In the past quarter-century, criminal prosecutions of corporations have grown more frequent.   

Corporate criminal liability – despite the absence of a “body to kick and soul to be damned”1 – was sanctioned almost 100 years ago in a U.S. Supreme Court decision making a corporation responsible for an act done by an authorized agent of the company.2  

The principle since has been extended so that under civil and agency law doctrine – known as respondeat superior (“let the master answer” – the employer is responsible for the acts of employees) – even employees and agents acting contrary to corporate policy and instructions have bound their corporate employers to criminal sanctions.3

While these precedent-establishing cases involved violations of federal antitrust statutes that specifically provided for corporate criminal liability based on employees’ actions, the types of federal criminal prosecutions in the past quarter-century are much broader.  Increasingly, companies have been charged with traditional criminal violations such as obstruction of justice, false statements, and mail and wire fraud under statutes that, when applied to individual defendants, require proof of intentional acts and some culpable state of mind.

By contrast, under the standard of respondeat superior, no intentional act of the collective entity is necessary for conviction and all the collateral consequences that flow from it.  This principle has been interpreted by lower courts to attach liability to the corporation as long as the employee or agent acted within the scope of his or her employment, with some modicum of intent to benefit the corporation,4 no “matter how befuddled.”5

A criminal indictment alone can have immediate consequences for corporations, such as licensing and permit revocations that threaten their viability. This reality can directly affect how companies defend against and react to criminal investigations and prosecutions in the United States. Resources often are devoted to a coordinated attempt to stave off potential business damage rather than to a well-mounted legal defense.

The spectacular collapse in 2002 of Arthur Andersen, one of the five largest international accounting firms, vividly illustrates the specter of such rapid, interrelated events. Because the criminal act of even one employee in a company can result in the entire company’s conviction, the livelihood of all its employees and suppliers are in imminent jeopardy irrespective of their own personal non-involvement and “no-fault” status. 

Upon indictment for obstruction of justice growing out of a handful of its partners’ auditing work for Enron, Andersen would have lost its auditing licenses in multiple jurisdictions.  Andersen relinquished those licenses, closed its U.S. offices, and turned its efforts to defending itself in court.  Despite the ultimately successful legal challenge, three years later, on appeal to the U.S. Supreme Court, Andersen’s international workforce of 85,000 rapidly dispersed because Anderson could no longer do business. The company never recovered.

Andersen’s dramatic demise catapulted discussion of the fundamental legal principles on which the U.S. government’s prosecution rested onto the talk show circuit and fostered public understanding of these interrelated issues.

In questioning the wisdom of a prosecution that many average citizens viewed as an unfair loss of jobs for most of Andersen’s employees,6 the public quickly became acquainted with the hard facts of criminal indictment for companies.  People began to understand that not only fines and the possibility of court supervision of company affairs affect the company’s judgment on whether to fight charges or negotiate a plea with the federal government. Equal if not more compelling are all the companion consequences for employees, suppliers, shareholders, and communities.

The Challenge to Corporate Criminal Liability

This cascading scenario of legal causes and effects motivated the recent friend of the court brief filed in support of Ionia’s appeal. Ionia’s legal supporters7 on this single issue include an alliance of business interests -- the Association of Corporate Counsel, the U.S. Chamber of Commerce, the National Association of Manufacturers – with more traditional criminal defense groups – the National Association of Criminal Defense Lawyers and the New York State Association of Criminal Defense Lawyers, who until fairly recently have not visibly championed corporate causes. The 30-year-old Washington Legal Foundation, which has recently taken up the defense of “business civil liberties,” is also in the group.

In its challenge, the coalition argues that corporations (and other organizations treated similarly under U.S. law) ought to be able to escape criminal liability if they have acted as responsible corporate citizens, making serious efforts to prevent and detect misconduct in the workplace. 

They can demonstrate good faith by implementing effective ethics and compliance programs. This approach coincides with the structure and direction of other areas of law dealing with organizational liability for the acts of agents and employees, such as sexual harassment under Title VII. It is consistent with the goals of corporate criminal law – to deter and detect wrongdoing.  And it encourages prevention, detection, and self-reporting by corporations, as pioneered by the judicial policy of the federal organizational sentencing guidelines.

The heart of the coalition’s legal challenge is that the civil law standard of respondeat superior is inconsistent with recent Supreme Court rulings on analogous civil liability issues.8  It mounts a two-pronged argument based on the theory and outcome of affirmative action cases under Title VII of the 1964 Civil Rights Act. 

In a pair of 1998 cases,9 the Supreme Court rejected the usual rule in civil cases – that vicarious liability arises from all acts of employees acting within the scope of their employment – and instead restricted liability to the acts of supervisors.

The justices first determined that an employer is entitled to defend itself by demonstrating that it has reasonable policies in place to deter the offending employee’s conduct.  The fact that the aggrieved employee has not made use of the employer’s system of redress may also be considered in this defense.  A year later, in a second case, the court refused to impose punitive damages on companies (even though authorized by statute) unless the offending action was authorized or ratified by an employee acting in a managerial capacity.10

The gist of the coalition’s argument focuses on the historic legal distinctions between civil and criminal law and the policy underlying the Supreme Court’s rationale for these important decisions.

First, civil law standards of liability have traditionally been less rigid than criminal standards, primarily because they do not involve the loss of liberty as a potential consequence.  The coalition maintains that, if the Supreme Court considers vicarious liability too severe a standard for civil punitive damages, the criminal law standards should be treated similarly and no more severely. The coalition bolsters its position by arguing that laws providing for civil punitive damages and laws providing criminal penalties share a common policy goal:  they are intended to punish and prevent further misconduct to achieve the two objectives of retribution and deterrence. 

When a corporation has undertaken all reasonable measures to deter and detect the employee’s criminal actions, the company has done all that can be expected, i.e., there is nothing that the criminal law is serving to deter or punish since there is no action by the corporation that it should have otherwise taken. (emphasis in original).11

Because similar public policy considerations are at the foundation of both criminal law and civil punitive law, the coalition contends that the same remedy should be available to corporations in the federal criminal context as in Title VII civil cases -- permit indicted companies to raise the demonstrated effectiveness of their ethics and compliance programs as an affirmative defense at the trial.  The Model Penal Code, a prototype developed by the American Law Institute, takes a similar approach,12 and numerous states have either limited vicarious corporate liability to circumstances where senior corporate officers are at fault, or provide a due diligence defense of some nature.13

The coalition also aptly points out that promoting effective compliance programs is a central goal of the federal sentencing guidelines for organizations (it could have bolstered its case a bit more with an explanation of the guidelines’ theoretical and policy basis).  When the organizational sentencing guidelines were promulgated in 1991, the Sentencing Commission, an independent judicial agency created by Congress, acknowledged that its effort to promote deterrence of corporate crime relied heavily on a belief that encouraging strong compliance programs and self-reporting would achieve this goal.  As the first chairman of the Commission observed about this developmental effort,

The Commission broke new ground [after four years of public debate and comment] in this area in the hope that its approach would foster crime control.14 

In 2004, the Commission reaffirmed its commitment to the viability of corporate ethics and compliance programs, making many of the criteria more rigorous to reflect the lessons learned by the corporate sector in more than a decade of practical experience and implementation.15

The Government’s View

In its reply to Ionia’s appeal, the government contends that evidence of corporate compliance programs does not bear on Ionia’s actual liability under the current state of the law.  Rather, such evidence may be and, in Ionia’s case, was, considered by the jury in determining whether an employee acted within the scope of employment and with some intention to benefit the corporation.16

The government addresses the coalition’s arguments in a single page, stating that existing law on the standards for corporate criminal liability cannot be overturned other than by the U.S. Supreme Court or by the Second U.S. Circuit sitting en banc. The remainder of the government’s brief focuses on the maritime laws under which Ionia was convicted, and various sentencing guidelines used to calculate the monetary penalty.

Whether the Second Circuit judges currently hearing (use consideration again in next sentence)  Ionia’s case will seriously consider this challenge to corporate criminal liability, given that it has ample other factual and less ground-breaking reasons on which to rule on Ionia’s conviction, remains to be seen and a ruling may not be forthcoming for several months.  Nonetheless, the case is the first contemporary legal opportunity to mount such a challenge17and provides a good opportunity to revisit important legal and policy issues.

Sound Policy Exists to Guide This Approach

The coalition’s argument represents the logical culmination of the policy of the Sentencing Commission that, since 1991, has fostered the prevention and early detection of corporate wrongdoing by encouraging effective ethics and compliance programs.  

This approach was visionary in its day. The Commission identified seven broad steps based on sound risk management principles that would encourage prevention and early detection. These quickly became known as “the seven minimum steps for an effective ethics and compliance program,” although the Commission did not use those words in the guidelines until they had been in currency in the business community for 15 years.18

Whether to reduce the corporation’s potential penalty is to be measured by a standard of reasonableness, not perfection.19 The guidelines recognize the inevitability of errant behavior in organizations that often have more employees than towns have residents.  A town, despite a well-intentioned and trained police force and educational system, cannot guarantee that any single resident will not stray from the law-abiding path. In such a case, how heavily should the town be collectively punished for its resident’s behavior?  Finding a balanced response to this question was central to the Commission’s analysis and policy.

 Although they are not mandatory, the guidelines have been the catalyst for the enormous proliferation of ethics and compliance programs in corporate America (and beyond).  These programs have been accompanied by serious professional efforts to develop, refine and measure best practices so that today there is a substantial body of expert knowledge from which courts may extrapolate assessment standards.20

An essential part of the partnership between business and government envisioned by the Commission is the responsibility of business to police itself by investigating and reporting malfeasance to the proper authorities – a logical progression of a well-implemented ethics and compliance program focused on prevention, detection and remediation. 

Further Policy Considerations

Another outcome of what the coalition proposes would be to let judge and jury determine corporate liability at the trial stage.  Under the current standard of respondeat superior there is little, if any, room for a factual defense once the illegal action has been established and the employer ascertained.  Focus shifts to mitigating consequences and obtaining favorable terms under a negotiated plea agreement with federal prosecutors.21

Under the coalition’s proposal for an affirmative defense, the jury would be able to weigh the evidence and assess the diligence of the corporation’s efforts to inform, train, and oversee its workforce in complying with the law and its policies.  This approach would not relieve an indicted corporation of the expense of defending itself.  It would still bear the significant burden of raising and introducing evidence. The proposed standard would, however, afford a corporate citizen the opportunity to counter public charges of malfeasance by presenting evidence of its commitment to business integrity in the workplace. The proposal if adopted also is likely to encourage more companies to adopt well-implemented programs and ensure that they are embedded into the organizational culture as the Sentencing Commission encourages.22

Adopting or expanding ethics and compliance programs would necessarily be a long-term undertaking and a commitment of substantial resources. Evidence of a hastily instituted program after the discovery of wrongdoing would be unlikely to carry the day in court.  A quick fix in the face of indictment would not meet the guidelines’ level of scrutiny, and companies would have to have undertaken these efforts as part of long-term strategic commitments to gain their benefits.  Public education about these principles would also be essential.

The knowledge and experience exist for this approach to be feasible.  The principles of the organizational sentencing guidelines are widely understood and adopted throughout corporate America and many regulatory agencies.23  Sound research methods exist to quantify and evaluate compliance and ethics programs.

Benchmarking comparisons are becoming more prevalent, thanks in no small part to the leadership of some forward looking corporations that have taken the initiative as part of their own risk management and good governance standards.24

The new approach should not burden the judicial system unduly since such defenses and the mechanisms for their evidentiary use already exist in analogous, complex civil cases. Corporate criminal prosecutions and convictions make up an extremely small portion of the entire federal docket in contrast to cases involving individual defendants, 25 and there is no realistic expectation of the inward collapse of the federal judicial system. Indeed, many states have adopted various versions of approaches similar to what the coalition is now proposing.

In fact, such an approach could conceivably conserve court resources.  By allowing a legitimate defense of a corporation’s internal systems, the jury would have the opportunity to fashion a remedy that is more balanced under the circumstances of the particular case and potentially easier to assess by having these facts at hand.  Such determinations by the jury would eventually become adopted in practice, serving as a template for cost-effective and efficient procedures.  And by giving additional encouragement to corporations to have robust ethics and compliance programs, and thus greater transparency, the need to prosecute corporations might ultimately diminish.

A Dialogue Whose Time Has Come

Given the very real and extensive consequences for the entire community of  corporate stakeholders – customers, employees, suppliers, local communities, taxing authorities – resulting from criminal prosecution and conviction, it is sound policy to find an accommodation in existing law and contemporary practice.  The affirmative legal defense suggested by the coalition in challenging Ionia’s conviction provides one such approach.  It also offers a broader legal platform for the federal organizational sentencing guidelines, with their fundamental focus on prevention, detection, remediation and self-reporting, to evolve further.

The experience of all necessary players – prosecutors, corporations, judges, and corporate experts – has been broadened in recent years, and the time may be at hand for a shift in liability standards based on this important body of knowledge.  Regardless of its outcome, the Ionia case will be significant for advancing the dialogue and moving the process forward for more considered attention to the value of ethics and compliance programs in the business world.

 

In This Issue

• The Policy Report By Paula J. Desio, ERC Chair on Ethics Policy:
  Ethics and Compliance Programs May Get Their Day in Court. Will they soon provide a legal defense to criminal liability?
• ERC Vice-Chair Scott Harshbarger: Working to Change the Rules of the Game
• Tough Times. Tough Actions.
  Column By Patricia J. Harned, Ph.D. President, ERC.
• ERC's Government Roundtable Takes the Long View