You are on page 1of 46

BUCYMACRO.

DOC

2/9/2005 3:34 PM

Carrots and Sticks: Post-Enron Regulatory Initiatives


Pamela H. Bucy Introduction....................................................................... 279 I. Recent Regulatory Initiatives to Combat Corporate Corruption .............................................. 281 A. Legislative Initiatives ....................................... 281 1. The Sarbanes-Oxley Act of 2002.................. 281 a. New Crimes and Tougher Sentences...... 281 (1) New Crimes ................................ 282 (2) Stiffer Sentences for Existing Crimes ........................................ 289 (3) New Duties for Counsel ............. 290 2. The Feeney Amendment of the PROTECT Act............................................ 291 B. Recent Initiatives by the Executive Branch Addressing Corporate Corruption..................... 293 1. The Ashcroft Memorandum ...................... 293 2. The Thompson Memorandum ................... 293 C. Recent Initiatives by Administrative Agencies Addressing Corporate Corruption ..... 295 1. Securities and Exchange Commissions Promulgation of Standards for Professional Conduct for Attorneys............ 295 a. Reporting Up the Ladder ..................... 295 b. Noisy Withdrawal................................. 297

Bainbridge Professor of Law, University of Alabama. The author most gratefully acknowledges the support of Dean Ken Randall, the University of Alabama Law School Foundation and the Ball Family Fund. The author thanks Kevin Davidson and Bradley Hayes for their research assistance. The author expresses her deepest gratitude to the Buffalo Criminal Law Center; Professor Markus Dirk Dubber, Buffalo School of Law and Director, Buffalo Criminal Law Center; and Joseph Schneider, Managing Editor of the Buffalo Criminal Law Review for their graciousness, hospitality and vision in creating one of the best symposia I have had the pleasure of attending.

BUCYMACRO.DOC

2/9/2005 3:34 PM

278

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

2. United States Sentencing Commissions Amendments to the Sentencing Guidelines..................................................... 299 a. Increased Range for Obstruction of Justice Offenses ...................................... 299 b. Increased Range for Fraud Offenses ...... 301 c. Amendments to Organizational Sentencing Guidelines ............................ 302 (1) Guidelines Addressing Corporate Compliance Plans...... 303 (2) Guidelines Regarding an Organizations Reporting Requirement ............................... 304 D. Recent Initiatives by the American Bar Association......................................................... 304 III. The Two Paths Chosen by the Recent Regulatory Initiatives Aimed at Corporate Corruption............. 306 A. Path One: Drafting Insiders Who Know What Is Going On.............................................. 306 B. Path Two: Bad Things That Happen to Insiders Who Dont Assist Law Enforcement ... 310 IV. Will the Regulatory Initiatives Work? .................... 313 A. Reasons to Think the Reforms Will Work ........ 313 B. Reasons to Think the Reforms Will Not Work . 315 C. A Helpful Option ............................................... 318 Conclusion ......................................................................... 322

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

279

INTRODUCTION Recent corporate scandals such as Enron,1 Adelphia,2 HealthSouth,3 Tyco,4 and Worldcom5 have led to a spate of regulatory initiatives, including passage of the SarbanesOxley Act of 2002,6 that have changed the landscape of corporate governance. The intended effect of these initiatives is enhanced integrity and public confidence in American financial markets.7 There also will be unintended effects of these regulatory initiatives. There always are. This article reviews these regulatory initiatives, their intended impact and their likely unintended consequences. Part one discusses the regulatory initiatives passed since 2002 to address corporate corruption. It is interesting to note the variety of sources responsible for these initiatives. These reforms come from legislative, executive, and administrative governmental bodies, as well as the American Bar Association. Part one discusses the following: (1) Legislative Initiatives: (a) The SarbanesOxley Act of 2002, which creates new crimes8 and longer prison sentences for existing crimes,9 and places greater demands on corporate counsel.10 (b) The PROTECT Act,11 specifically, the Feeney Amendment12 which limits downward departures. Downward departures have been
1. See Pamela H. Bucy, Private Justice, 76 S. Cal. L. Rev. 1, 9-10 (2002) [hereinafter Bucy, Private Justice]. 2. See Kathleen Brickey, From Enron to WorldCom and Beyond: Life and Crime after Sarbanes-Oxley, 81 Wash. U. L.Q. 357, 382, app. A (2003). 3. Id. at 389-91. 4. Id. at 399-400. 5. Id. at 400-01. 6. Pub. L. No. 107-204, 116 Stat. 745 (2002). 7. S. Rep. No. 107-205 (2002). 8. 18 U.S.C. 1348, 1350, 1513(e), 1519 (2004). 9. Sarbanes-Oxley, Pub. L. No. 107-204 903 (2002) (amending 18 U.S.C. 1341 (mail fraud) and 1343 (wire fraud)). 10. Id. 906 (2002) (creating 18 U.S.C. 1350). 11. Prosecutorial Remedies and Tools Against the Exploitation of Children Today Act of 2003 (PROTECT Act), Pub. L. No. 108-21, 117 Stat. 650, 805 (2003). 12. Protect Act Pub. L. No. 108-21 401(m), 18 U.S.C. 3553.

BUCYMACRO.DOC

2/9/2005 3:34 PM

280

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

the major way federal criminal defendants obtain sentencing leniency;13 reducing their availability means criminal sentences will be stiffer. (2) Executive Initiatives: (a) The Ashcroft Memo,14 an internal U.S. Department of Justice directive that instructs federal prosecutors to charge, and allow pleas of guilt only to the most serious, provable offenses. (b) The Thompson Memo,15 another internal DOJ directive, that outlines factors federal prosecutors should consider when deciding whether to charge organizational entities with crimes. Greater cooperation with law enforcement is a key factor in avoiding or minimizing criminal liability. (3) Administrative Initiatives: (a) Rules issued by the Securities and Exchange Commission (SEC) governing attorneys who practice before the Commission.16 These rules require greater vigilance in reporting corporate wrongdoing. (b) Amendments to the United States Sentencing Guidelines (USSG) that also require greater cooperation with regulators.17 (4) Private Initiatives: Amendments by the American Bar Association to the Model Rules of Professional Conduct requiring a more proactive role for corporate counsel in policing corporate misconduct.18 The intended effect of each of the above initiatives is, of course, enhanced honesty, accountability, and public
13. Cf. Nina Marino, Interpreting FeeneyA Defense Perspective, A.B.A. National Institute on White Collar Crime app. P-1 (2004) (course materials). 14. Memorandum from Attorney General John Ashcroft to All Federal Prosecutors, Department Policy Concerning Charging Criminal Offenses, Disposition of Charges, and Sentencing (Sept. 22, 2003), available at http://news.findlaw.com/hdocs/docs/doj/ashcroft92203chrgmem.pdf (last visited Nov. 29, 2004) [hereinafter Ashcroft Memorandum]. 15. Memorandum from Deputy Attorney General Larry D. Thompson to United States Attorneys, Principles of Federal Prosecutions of Business Organizations (Jan. 20, 2003), available at http://www.usdoj.gov/dag/cftf/business_organizations.pdf (last visited Nov. 29, 2004) [hereinafter Thompson Memorandum]. 16. Sarbanes-Oxley, Pub. L. No. 107-204 307 (2002) (Congresss directive to the SEC); 17 C.F.R. 205. 17. U.S. Sentencing Guidelines Manual ch. 8 (1998). 18. Model Rules of Profl Conduct R. 1.6 (revealing client confidence) and 1.13(b) (requiring counsel to report organizational wrongdoing within the organization) (2004).

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

281

confidence in American financial markets. Part two of this article highlights the two ways each of these initiatives has chosen to reach this goal: they either increase the consequences for those who commit intentional acts of corporate fraud or they draft industry insiders, including corporate counsel, into serving as the eyes and ears of law enforcement. Some choose both paths. The common paths chosen do not appear to result from coordination among policy makers but rather, a function of conventional wisdom. Part three of this article assesses the likely outcome of these regulatory initiatives. There are reasons to believe they may be successful in taming corporate corruption. On the other hand, there are reasons to believe that they will interfere with effective corporate governance. Part three of this article concludes by offering suggestions for improving upon the regulatory design typified in all of these reform efforts. I. RECENT REGULATORY INITIATIVES TO COMBAT CORPORATE CORRUPTION A. Legislative Initiatives 1. The Sarbanes-Oxley Act of 200219 a. New Crimes and Tougher Sentences Sarbanes-Oxley created four new crimes, all addressing financial frauds;20 raised the statutory term of imprisonment for existing offenses already employed to prosecute financial frauds; and directed the United States Sentencing Commission to review (fair translation: increase) existing sentencing guidelines for certain existing white collar fraud offenses.21 The net effect of these provisions of Sarbanes-Oxley raises the stakes for
19. Pub. L. No. 107-204, 116 Stat. 745 (2002). 20. 18 U.S.C. 1348, 1350, 1513(e), 1519 (2004). 21. Sarbanes-Oxley, Pub. L. No. 107-204 905(2002).

BUCYMACRO.DOC

2/9/2005 3:34 PM

282

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

those who commit financial thievery, those who assist in it, and those who fail to alert authorities about it. (1) New Crimes (a) 18 U.S.C. 1519: Destruction, Alteration, or Falsification of Records in Federal Investigations and Bankruptcy22 Section 1519, which carries a term of imprisonment of not more than twenty years, makes it a crime to: (1) knowingly, (2) alter, destroy, mutilate, conceal, cover up, falsify or make any false entry, (3) in any record, document or tangible object, (4) with the intent to impede, obstruct or influence an investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11 [bankruptcy code] or in relation to or contemplation of any matter or case.23 There are four notable features of this offense. First, it is expansive. The conduct it covers is broad: to alter, destroy, mutilate, conceal, cover up, falsify or make any false entry of records at issue in federal investigations. And, its jurisdictional reach is broad: it applies to private as well as public companies. Second, this offense contains a dual intent element: it requires proof of general intent (knowingly) as well as proof of specific intent (intent to impede, obstruct or influence an investigation). Third, this offense closes loopholes in existing obstruction of justice offenses. Sections 1512 (title 18, United States Code) and 1513, for example, do not cover document destruction;24 sections 1503,25 1505,26 1512,27 and 151928
22. Created by Sarbanes-Oxley, Pub. L. No. 107-204 802 (2002). 23. 18 U.S.C. 1519 (2004). 24. 18 U.S.C. 1512, 1513 (2004) (apply to retaliation against witnesses, victims and informants). 25. 18 U.S.C. 1503 (2004) (applies to grand jury or court proceedings). 26. 18 U.S.C. 1505 (2004) (applies to matters before departments, agencies and committees). 27. 18 U.S.C. 1512 (2004) (applies to matters occurring while an official

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

283

apply only when a proceeding or investigation is ongoing at the time of the conduct. Lastly, the term of imprisonment for violations of this offense, not more than twenty years, is unusual. Before Sarbanes-Oxley, most felonies in the federal criminal code imposed a five year maximum term of imprisonment. (b) 18 U.S.C. 1513(e): Retaliation against Informants29 Section 1513(e), which carries a term of imprisonment of not more than ten years, makes it a crime to: (1) knowingly, (2) with intent to retaliate, (3) take any action harmful to any person, including interfering with lawful employment or livelihood, (4) for providing to a law enforcement officer, (5) truthful information relating to the commission or possible commission of any federal offense. The notable features of this offense are its dual intent element (knowingly and intent to retaliate), its ten year cap on imprisonment (not as onerous as 18 U.S.C. 1519 but longer than most federal felonies), and its narrow scope. This provision is narrow in two respects: First, it prohibits retaliation only when the person providing information about a possible offense gives the information to a law enforcement officer.30 Providing information about fraud to the media, for example, would not be covered. Nor would 1513(e) apply when information is provided internally, within corporate ranks. Second, in any situation involving complex fraud, misinformation almost always is intertwined with accurate information. Section 1513(e) applies only when truthful information is provided; thus, its efficacy will be questionable when, as will almost always be the case, accurate and inaccurate information is provided. In two respects 1513(e)s scope is broad. Like newly created
proceeding is pending). 28. 18 U.S.C. 1519 (2004) (applies to investigations within the jurisdiction of any department or agency of the United States). 29. Sarbanes-Oxley, Pub. L. No. 107-204 1107 (2002). 30. 18 U.S.C. 1513(e) (2004).

BUCYMACRO.DOC

2/9/2005 3:34 PM

284

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

1519, 1513(e) applies to both private and publicly traded companies. Also, 1513(e)s protection extends to non-employees as well as employees. All 1513(e) requires is that a defendant interfere with a persons lawful employment or livelihood. Thus, for example, interfering with a competitors livelihood by defaming the competitor in retaliation for the competitors reporting wrongdoing to a law enforcement officer would fall within 1513(e). As a side note, it is interesting to compare the coverage of 1513(e) to the private cause of action also created by Sarbanes-Oxley for persons who have been retaliated against for reporting corporate wrongdoing. Section 806 of Sarbanes-Oxley creates a private cause of action, found at 18 U.S.C. 1514A, for persons who are discriminated against by their employers because they reported corporate wrongdoing.31 To seek relief under 1514A, a plaintiff must first file a complaint with the United States Secretary of Labor. If the Secretary of Labor has not issued a final decision within 180 days of the filing of the complaint, the plaintiff may bring an action at law or equity in federal district court.32 There is a ninety day statute of limitation from the date of the violation.33 A prevailing plaintiff is

31. Section 806 of Sarbanes-Oxley created 18 U.S.C. 1514A, which provided that: any person who alleges discharge or any other discrimination against any publicly traded company or any officer, employee, contractor, subcontractor, or agent of such company that may discharge, demote, suspend, threaten, harass, or in any manner discriminate against an employee in the terms and conditions of employment. because of any lawful act done by the employee: to provide information, cause information to be provided, or otherwise assist in an investigation regarding any conduct which the employee reasonably believes constitutes [a violation of numerous listed financial and security crimes]; or when the information or assistance is provided to or the investigation is conducted by (A) a Federal regulatory or law enforcement agency; (B) any Member of Congress or any committee of Congress; or (C) a person with supervisory authority over the employee . . . or to file, cause to be filed or assist in a proceeding relating to [a violation of numerous listed financial and security crimes.] 32. Id. 1514A(b). 33. Id. 1514A(b)(2)(D).

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

285

entitled to all relief necessary to make the employee whole, and is specifically entitled to reinstatement with the same seniority status that the employee would have had, but for the discrimination, . . . back pay, with interest; and compensation for special damages, including litigation costs, expert witness fees, and reasonably attorney fees.34 Aside from the obvious point that 1513(e) is a crime and 1514A is a civil cause of action, there are several notable differences between the two sections. First, coverage provided by 1514A, the civil cause of action, is broader than that provided by 1513(e)s crime. Unlike 18 U.S.C. 1513(e), which applies only when an individual reports wrongdoing outside corporate ranks to a law enforcement officer,35 1514A covers discriminatory actions taken against employees who report the wrongdoing Also, whereas internally within the organization.36 1513(e) requires proof of intent by a defendant,37 1514A requires no proof of intent by a defendant beyond establishing causation.38 In other respects, however, the civil cause of action in 1514A is narrower than the crime in 1513(e). Section 1513(e) applies to publicly traded and private companies,39 while 1514A applies only to publicly traded companies.40 Also, section 1513(e) protects against action harmful to any person,41 while 1514A protects only employees.42 As discussed infra, compared to other civil causes of action designed to protect corporate whistleblowers, 1514A is fairly anemic. Unlike the civil False Claims Act (FCA),43 for example, which applies to false claims
34. Id. 1514A(c)(1) & (2). 35. 18 U.S.C. 1513(e) (2004). 36. 18 U.S.C. 1514A(1)(C) (2004). 37. Section 1513(e) requires proof that a defendant acted knowingly, with the intent to retaliate. 38. Section 1514A requires proof that the discrimination action was taken because of any lawful act done by the employee. 39. 18 U.S.C. 1513(e) (2004). 40. 18 U.S.C. 1514 (2004). 41. 18 U.S.C. 1513(e) (2004). 42. 18 U.S.C. 1514 (2004). 43. 31 U.S.C. 3729-3733.

BUCYMACRO.DOC

2/9/2005 3:34 PM

286

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

submitted to the federal government, 1514A presents a cumbersome procedural process,44 minimal damages,45 limited ability to qualify as a plaintiff,46 and a limited statute of limitations.47 (c) 18 U.S.C. 1350: Failure of Corporate Officers to Certify Financial Reports48 Section 1350, which carries a ten year maximum term of imprisonment for knowing49 violations and a twenty year maximum for wilful violations,50 has garnered considerable publicity.51 This section applies only to
44. Under 1514A, plaintiffs must file with the Secretary of Labor and may proceed on their own only after waiting 180 days to allow the Secretary to file suit. 18 U.S.C. 1514A(b)(1)(A). There is no such requirement under the civil False Claims Act. 45. Under 1514A, the non-equity relief plaintiffs may obtain is limited to double damages, reimbursement of litigation costs, and reinstatement, 18 U.S.C. 1514A(c). Under the civil False Claims Act, the non-equity relief plaintiffs may obtain can be up to 30 percent of the judgment as well as reimbursement of litigation costs. FCA judgments are comprised of treble damages and significant penalties, in most cases, and can be quite large. For example, recent judgments in FCA qui tam cases include an $875 million settlement from TAP Pharmaceuticals, 55 Healthcare Fin. Mgmt. 10 (2002); a $745 million settlement with DCA Healthcare Corporation to resolve some of the alleged FCA violations pending against HCA; a $385 million settlement with National Medical Care, Inc.; a $325 million settlement with SmithKline Beecham Clinical Laboratorie; a $325 million settlement with National Medical Enterprises; and a $110 million settlement with National Health Laboratories. John T. Boese, Civil False Claims and Qui Tam Actions 1.05[A] (2004). 46. Section 1514A requires that in order to have standing plaintiffs must be damaged from the conduct at issue, 18 U.S.C. 1514A(b)(1). The civil False Claims Act confers plaintiff standing to anyone with information of a violation. Vermont Agency of Natural Res. v. United States, 529 U.S. 765, 773 (2000). 47. Section 1514A provides a ninety-day statute limitation from the date of the violation, 18 U.S.C. 1514A(b)(2)(D). The civil False Claims Act provides for a six-year statute of limitations from the date of the violation or three years after the date when facts material to the right of action are known or reasonably should have been known by the official of the United States charged with responsibility to act in the circumstances, but in no event more than 10 years after the date on which the violation was committed, whichever occurs last. 31 U.S.C. 3731(b). 48. Sarbanes-Oxley, Pub. L. No. 107-204 906 (2002). 49. 18 U.S.C. 1350(c)(1) (2004). 50. Id. 1350(c)(2). 51. W. Warren Hamel, Thomas J. Kelly, Jr. & Kathleen S. Dolan, They Got

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

287

publicly traded companies,52 and requires that a companys chief executive officer and chief financial officer certify that information contained in reports filed with the SEC fairly presents the financial condition and results of business The true impact of this operations of the issuer.53 provision remains to be seen. As one commentator has said, this provision, single-handedly, may re-shape the structure of American corporations.54 Section 1350 requires more than compliance with Generally Accepted Accounting Principles (GAAP) and more than an absence of falsity or fraud. Its requirement that company reports convey a fair presentation of the financial condition of the issuer goes beyond GAAP or even existing fraud and false statement offenses.55 Avoiding chicanery is not enough; under 1350, a corporate officer will go to prison for failing to tell about all possible financial problems, failing to reveal all possible financial problems, and failing to disclose all possible financial problems. For a corporate official to confidently certify reports under the fair representation standard, she must rely upon the processes and people who generated the reports. To acquire this level of confidence many corporate executives have, since the passage of Sarbanes-Oxley, instituted top-to-bottom assessments of corporate systems for collecting, categorizing and compiling financial data.56

Tougher, Legal Times, Oct. 7, 2002, at 34 [hereinafter They Got Tougher]. 52. 18 U.S.C. 1350(a) (2004). 53. 18 U.S.C. 1350(b) (2004). 54. They Got Tougher, supra note 51, at 34. 55. See, e.g., 18 U.S.C. 287 (requires a false claim), 1001 (requires a false statement or concealment of a material fact), 1341 (requires fraud or false or fraudulent pretenses). 56. They Got Tougher, supra note 51, at 34 (Companies, both large and small, must now devise systems that will allow the officers who must sign the financial reports to rely absolutely on the process and people by which the information for the reports was generated.).

BUCYMACRO.DOC

2/9/2005 3:34 PM

288

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

(d) 18 U.S.C. 1348: Criminal Penalties for Defrauding Shareholders of Publicly Traded Companies57 Section 1348, which carries a twenty-five year maximum term of imprisonment, makes it a crime to: (1) knowingly, (2) execute or attempt to execute a scheme or artifice to defraud any person in connection with any security of any issuer, or to obtain money or property in connection with the purchase or sale of securities by means of false or fraudulent pretenses, representations or promises.58 This mail fraud hybrid offense is extremely broad in three respects. First, whereas 18 U.S.C. 1350, the newly created certification offense, applies only to those who sign reports filed by publicly traded companies, 1348 applies to any effort to defraud those others who deal with publicly traded companies. Thus, 1348 will apply to oral conversations, informal reports, presentations and the like, not just official reports filed with the SEC.59 Second, like the mail,60 wire,61 and bank fraud62 scheme to defraud statutes, 1348 includes unsuccessful and nascent efforts to defraud since a scheme or artifice to defraud encompasses early, preliminary plans to defraud.63 Third, the mens rea element in 1348 is fairly minimal, for a criminal offense. Unlike the other new crimes created by Sarbanes-Oxley which contain a specific intent element,64
57. Sarbanes-Oxley, Pub. L. No. 107-204 807 (2002). 58. 18 U.S.C. 1348 (2004). 59. 18 U.S.C. 1348 applies to anyone who defrauds or attempts to defraud anyone in connection with any publicly traded company, 1348(1), or in connection with the purchase or sale of a publicly traded company, 1348(2). 60. 18 U.S.C. 1341 (2004). 61. 18 U.S.C. 1343 (2004). 62. 18 U.S.C. 1344 (2004). 63. While the mails or interstate carrier ( 1341) or interstate wire communication ( 1343) must be used before the crime is complete, the scheme to defraud need not be complete or successful. See, e.g., United States v. Andreadis, 366 F.2d 423, 431 (2d Cir. 1966); Byron v. United States, 273 F. 769, 772 (9th Cir. 1921). 64. 18 U.S.C. 1519 and 18 U.S.C. 1513(e), by comparison, require proof of specific intent, and 1350 includes an optional wilfulness (specific intent) requirement. See, e.g., Cheek v. United States, 498 U.S. 192, 201 (1991).

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

289

1348 requires only proof that a defendant acted knowingly.65 Given case law that interprets knowingly to include reckless disregard for the truth,66 1348 exposes corporate executives to expansive criminal liability. Section 1348 is also notable because of the unusually stiff term of imprisonment it carries. Even among the Sarbanes-Oxley crimes, 1348 stands out. It carries a possible maximum term of imprisonment of twenty-five years.67 (2) Stiffer Sentences for Existing Crimes Sarbanes-Oxley directly or indirectly increased the terms of imprisonment for existing crimes involving corporate wrongdoing in three ways. First, Sarbanes-Oxley amended the mail fraud and wire fraud statutes, long regarded as mainstay of fraud prosecutions,68 by increasing the statutory maximum possible term of imprisonment from five to thirty years.69 Second, Sarbanes-Oxley created a new conspiracy and attempt offense, 18 U.S.C. 1349, that differs from existing conspiracy and attempt crimes primarily in the maximum allowable term of imprisonment. The penalty under 18 U.S.C. 371, the major conspiracy offense in the federal code prior to Sarbanes-Oxley, provided a maximum possible sentence of five years imprisonment. Newly created 18 U.S.C. 1349 provides that attempts and conspiracies to commit crimes are subject to the same penalties as those statutorily prescribed for the offense(s) that was the object of the attempt or conspiracy.70 Since Sarbanes-Oxley dramatically increases the sentence for
65. 18 U.S.C. 1348 (2004). 66. See, e.g., United States v. Jewell, 532 F.2d 697, 698-704 (9th Cir. 1976). 67. 18 U.S.C. 1348 (2004). 68. Pamela H. Bucy, White Collar Crime, Cases and Materials 60 (1998). 69. Sarbanes-Oxley, Pub. L. No. 107-204 903 (2002) (amending 18 U.S.C. 1341 (mail fraud) and 1343 (wire fraud)). 70. Id. 902 (creating 18 U.S.C. 1349): Any person who attempts or conspires to commit any offense under this chapter shall be subject to the same penalties as those prescribed for the offense, the commission of which was the object of the attempt or conspiracy.

BUCYMACRO.DOC

2/9/2005 3:34 PM

290

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

existing fraud offenses (from five to thirty years) and created new crimes that carry unusual lengthy terms of imprisonment (ten and twenty years), the practical effect of 1348 is to increase sentences for most attempts and conspiracies. Lastly, Sarbanes-Oxley directed the United States Sentencing Commission to review sentencing guidelines for crimes involving obstruction of justice, crimes by organizations, and serious fraud offenses, to ensure that resulting sentences are severe enough to obtain deterrence.71 In April 2004, the Sentencing Commission completed this review and recommended increased sentences for a variety of fraud and fraud-related crimes and reductions in the availability of downward departures (the major vehicle by which convicted defendants may obtain reductions in their sentences), and required greater cooperation with regulators by convicted corporations. (3) New Duties for Counsel Fifteen years ago, in the midst of savings and loan scandals, Judge Stanley Sporkin, former head of the SECs Enforcement Division, asked:
Where were these professionals, a number of whom are now asserting their rights under the Fifth Amendment, when these clearly improper transactions were being consummated? Why didnt any of them speak up or disassociate themselves from the transactions? Where also were the outside accountants and attorneys when these transactions were effectuated? What is difficult to understand is that with all the professional talent involved (both accounting and legal), why at least one professional would not have blown the whistle to stop the overreaching that took place in his case.72

71. Id. 905. 72. Lincoln Sav. & Loan Assn v. Wall, 743 F. Supp. 901, 920 (D.D.C. 1990).

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

291

Echoing Judge Sporkins concerns,73 Congress directed the SEC in Section 307 of Sarbanes-Oxley [To] issue rules, in the public interest and for the protection of investors, setting forth minimum standards of professional conduct for attorneys appearing and practicing before the Commission in any way . . . .74 In 2003 the SEC did so, most notably by requiring that counsel report possible corporate wrongdoing up the ladder within an organization to whomever and whatever level is necessary to obtain an appropriate response. 2. The Feeney Amendment of the PROTECT Act In April, 2003 Congress passed the Prosecutorial Remedies and Other Tools to End the Exploitation of Children Today (PROTECT) Act.75 As its name implies, the Act deals almost exclusively with child pornography issues. On the eve of passage, the PROTECT Act was amended, in a bill introduced by Representative Tom Feeney.76 The Feeney Amendment directs the Sentencing Commission to substantially reduce[] the incidence of downward departures.77 In 2003, the U.S. Sentencing Commission issued new sentencing guidelines and revised existing guidelines to reduce the availability of downward departures.78 An understanding of the federal sentencing guidelines is necessary to appreciate the significance of the Feeney Amendment. The federal sentencing guidelines were created in 1984 with passage of the Sentencing Reform Act.79 The Act mandated an overhaul of sentencing for
73. 148 Cong. Rec. S6551 (daily ed., July 10, 2002) (statement of John Edwards). 74. Sarbanes-Oxley, Pub. L. No. 107-204 307 (2002). 75. Pub. L. No. 108-21, 117 Stat. 650 (2003). 76. Pub. L. No. 108-21 401(m), 117 Stat. 675 (2003) codified at 18 U.S.C. 3553. 77. 18 U.S.C. 3553(m)(2)(A) (2004). 78. The effective date for these guideline changes was October 27, 2003, but they apply retroactively to April 30, 2003. U.S.S.G., app. C. 79. 18 U.S.C. 3551-3742; 28 U.S.C. 991-998.

BUCYMACRO.DOC

2/9/2005 3:34 PM

292

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

federal crimes by abolishing parole. It also created a system for standardizing, to the extent possible, criminal sentences. Crimes are assessed points based upon factors such as the amount of money stolen or number of victims harmed. Defendants are assessed points based upon their criminal history. The total number of points determines the sentence a defendant receives.80 The only discretion a court has to reduce a defendants sentence is through downward departures.81 The Feeney Amendment limited the grounds available for downward departures.82 In the Feeney Amendment, Congress also changed the standard of review of sentences on appeal. Trial court rulings on downward departures are to be reviewed de novo rather than due deference.83 The practical effect of the Feeney Amendment and the Sentencing Commissions response to it is to encourage greater cooperation with regulators since cooperation is left as one of the few ways to obtain a downward departure. Realistically, the only way for a corporate defendant to reduce his or her sentence by obtaining a downward departure is to plead guilty and provide information to regulators as to who was involved in the wrongdoing, the extent to which individuals were involved, how the wrongdoing occurred and who the victims are.84

80. Excellent sources on federal sentencing policies include Thomas W. Hutchison et al., Federal Sentencing Law and Practice (2004); Corporate Sentencing Guidelines: Compliance & Mitigation (Jed S. Rakoff et al. eds., 1993). 81. 18 U.S.C. 3553(b) (2004). 82. For example, the Sentencing Guidelines issued pursuant to the Feeney Amendment restrict the availability of departures based on multiple circumstances and prohibit use of heretofore existing grounds for downward departures. 18 U.S.C. app. 651 (2004). See also U.S.S.G. 5K2.0. 83. 18 U.S.C 3553(d)(2). 84. Cf. Marino, supra note 13, app. P-1.

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

293

B. Recent Initiatives by the Executive Branch Addressing Corporate Corruption 1. The Ashcroft Memorandum85 In September 2003, Attorney General Ashcroft instructed federal prosecutors to charge the most serious, provable offense available, limit plea agreements to such offenses, and seek imposition of maximum sentences provided by statute. Exceptions to this charging policy are limited, must be justified in writing by the prosecutor and must be approved by an Assistant Attorney General.86 The primary exception available is to provide substantial assistance to law enforcement in its investigation or prosecution of another person.87 Standing alone, the Ashcroft Memo is not particularly significant. Its admonition: that prosecutors charge, and allow pleas to, only the most serious provable offense, is consistent with most existing prosecutive policies. Its intent, to standardize prosecutorial discretion to the extent possible, is laudable and appropriate. The Ashcroft Memo is significant when viewed in conjunction with the other regulatory initiatives enacted post-Enron which raise the stakes for those engaging in or failing to report corporate wrongdoing. 2. The Thompson Memorandum88 In January 2003, Assistant Attorney General Larry Thompson reissued the 1999 Holder Memorandum that set forth factors federal prosecutors should consider in deciding whether, and to what extent, to criminally charge organizations. Most factors remain unchanged from the Holder Memorandum and include what one would expect when the target is an organization: the nature and
85. 86. 87. 88. Ashcroft Memorandum, supra note 14. Id. Id. Thompson Memorandum, supra note 15.

BUCYMACRO.DOC

2/9/2005 3:34 PM

294

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

seriousness of the offense; the pervasiveness of wrongdoing within the corporation; the organizations history of similar conduct; the organizations timely disclosure of wrongdoing and willingness to cooperate in the investigation; the adequacy of the corporations compliance program and remedial actions; collateral consequences to innocent third parties; adequacy of other, lesser remedies.89 New in the Thompson Memo is the directive to prosecutors to explicitly consider a corporations willingness to cooperate with regulators by: identify[ing] the culprits within the corporation;90 mak[ing] witnesses available;91 disclos[ing] the complete results of its internal investigation;92 waiv[ing] attorney-client and work product protection . . . both with respect to communications between specific officers, directors and employees and counsel.93 The Memo cautions prosecutors to be wary of efforts by organizations to look like they are cooperating when they are not.94 The Thompson Memo clearly and unmistakably communicates that organizations are expected to help the

89. Id. 90. Id. 91. Id. 92. Id. 93. Id. 94. Prosecutors are told to be wary of: a corporations promise of support to culpable employees and agents, either through the advancing of attorneys fees, through retaining the employees without sanction for their misconduct, or through providing information to the employee about the governments investigation pursuant to a joint defense agreement . . .; a corporations effort to shield corporate officers and employees from liability by a willingness of the corporation to plead guilty; a corporations overly broad assertions of corporation representation of employees or former employees; a corporations inappropriate directions to employees or their counsel, such as directions not to cooperate fully with the investigation . . . Id.

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

295

No longer may an Government catch the crooks.95 organization simply exercise due diligence in preventing violations of the law by its agents. Now, an organization must aggressively investigate any wrongdoing that took place within its ranks and disclose all details: the who, what, when, and how, to the government. If the organization does not, if the organization does so incompletely or too slowly, it will be charged with crimes and with more serious crimes. C. Recent Initiatives by Administrative Addressing Corporate Corruption Agencies

1. Securities and Exchange Commissions Promulgation of Standards for Professional Conduct for Attorneys a. Reporting Up the Ladder Section 307 of Sarbanes-Oxley directed the SEC to establish minimum standards of conduct for attorneys who practice before the Commission. Pursuant to 307, the SEC issued Rule 205. Effective on August 5, 2003, Rule 205 applies to attorneys appearing and practicing before the Commission in the representation of an issuer96 who become aware of evidence of a material violation by the issuer or by any officer, director, employee or agent of the issuer.97 Rule 205 is mandatory: attorneys are required to report evidence of a possible violation to an issuers chief legal officer and/or the chief executive officer.98 If the attorney does not receive an appropriate response within a reasonable time, she shall report the evidence to the board of directors.99
95. Interview with United States Attorney James Comey Concerning the Department of Justices Policy on Requesting Corporations under Criminal Investigation to Waive the Attorney Client Privilege and Work Product Protection, ABA National Institute on White Collar Crime app. L-13 (2004) (course materials). 96. 17 C.F.R. 205.3(a) (2004). 97. 17 C.F.R. 205.3(b)(1) (2004). 98. Id. 99. 17 C.F.R. 205(b)(3). The rule provides that counsel report to the audit

BUCYMACRO.DOC

2/9/2005 3:34 PM

296

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

Attorneys who fail to comply with Rule 205 face civil penalties of fines up to $100,000, equitable relief, and administrative discipline by the SEC including censure, suspension, or disbarment.100 There is no private cause of action; only the SEC may enforce Rule 205.101 A number of interpretative questions exists as to Rule 205: What is evidence of a material violation? What is an appropriate response? To whom does the rule apply (only the attorney of record before the SEC on that matter or to all attorneys who have advised the issuer in any respect on the matter)?102 What should an attorney do if Rule 205 violates state ethics rules prohibiting the attorney from disclosing required information?103 Because of these interpretative questions, it remains to be seen how effective Rule 205 will be in detecting or deterring corporate wrongdoing.

committee of the board of directors, or to a committee of outside directors or to the board itself if neither of the above committees exist. 100. 17 C.F.R. 205.6(a), 15 U.S.C. 78u(d)(3) (2004). 101. 17 C.F.R. 205.7 (2004). 102. For an excellent discussion of this issue, see Robert S. Litt, Unsealing the Lawyers Lips: The Changing Contours of Attorney-Client Privilege in an Era of Corporate Fraud, A.B.A. National Institute on White Collar Crime app. C-1 (2004) (course materials) [hereinafter Litt, Changing Contours]. 103. The SEC rule seeks to preempt conflicting state ethics rules: An attorney who complies in good faith with provisions of this part shall not be subject to discipline or otherwise liable under inconsistent standards imposed by any state or other United States jurisdiction where the attorney is admitted or practices. 17 C.F.R. 205(c) (2004). It is too early to tell if this preemption provision will prevail. The Washington State Bar Association, for example, issued an opinion after adoption of the up-the-ladder rule stating that Washington attorneys were not permitted to reveal client confidences except under circumstances authorized by the Washington Code of Ethics. Washington State Bar Assn, June 1st Draft of Proposed Formal Opinion, The Effect of the SECs Sarbanes-Oxley Regulations on Washington Attorneys Obligations under the RPCs, available at http://www.wsba.org/lawyers/groups/ethics2003/formalopinion.doc (last visited Nov. 29, 2004). The SEC Commissioner responded with a letter reiterating that its regulation preempts contrary state rules. Giovanni P. Prezioso, Public Statement by SEC Official: Letter Regarding Washington State Bar Associations Proposed Opinion on the Effect of the SECs Attorney Conduct Rules (July 23, 2003), available at http://www.sec.gov/news/speech/spch072303gpp.htm (last visited Nov. 29, 2004).

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS b. Noisy Withdrawal

297

Initially, in response to 307 of Sarbanes-Oxley, the SEC proposed a rule104 that required counsel105 withdraw from representing her corporate client, give written notice of her withdrawal indicating that the withdrawal is based on professional considerations, and promptly disaffirm to the Commission any opinion, document, affirmation, representation [or] characterization . . . that the attorney has prepared or assisted in preparing . . . that the attorney reasonably believes is or may be materially false or misleading.106

104. Release No. 33-8150 (Dec. 2, 2002) (67 Fed. Reg. 71670). 105. The Proposed Rule applied to attorneys appearing and practicing before the Commission. 68 Fed. Reg. 6326 (Feb. 6, 2003). Rule 205 provides the following definitions: (a) Appearing and practicing before the Commission: (1) Means: (i) Transacting any business with the Commission, including communications in any form; (ii) Representing an issuer in a Commission administrative proceeding or in connection with any Commission investigation, inquiry, information request, or subpoena; (iii) Providing advice in respect of the United States securities laws or the Commissions rules or regulations thereunder regarding any document that the attorney has notice will be filed with or submitted to, or incorporated into any document that will be filed with or submitted to, the Commission, including the provision of such advice in the context of preparing or participating in the preparation of, any such document; or (iv) Advising an issuer as to whether information or a statement, opinion, or other writing is required under the United States securities laws or the Commissions rules or regulations thereunder to be filed with or submitted to, or incorporated into any document that will be filed with or submitted to, the Commission; but (2) Does not include an attorney who: (i) Conducts the activities in paragraphs (a)(1)(i) through (a)(1)(iv) of this section other than in the context of providing legal services to an issuer with whom the attorney has an attorney-client relationship; or (ii) Is a non-appearing foreign attorney. 17 C.F.R. 205.2(a) (2004). 106. Proposed Rule 205.3(d)(i); Release No. 33-8150 (Dec. 2, 2002) (67 Fed. Reg. 71670).

BUCYMACRO.DOC

2/9/2005 3:34 PM

298

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

Under the proposed rule, counsel was to take such action if she reasonably believed her client had not made an appropriate response within a reasonable time and the material violations are ongoing or about to occur.107 If the violations had already occurred and were not ongoing, counsel was not required to make the proscribed noisy withdrawal but was permitted to do so.108 This proposal became known as the noisy withdrawal rule. The SEC withdrew this proposal in the wake of significant opposition109 to its disregard of attorney-client privilege, its effort to enlist counsel into serving as eyes and ears of regulators, and its likely inconsistency with many state codes of ethics.110 In its place, the SEC issued Rule 205.3(d). Rule 205.3(d) tracks the prior rule except that the company (rather than counsel) is required to notify the SEC of counsels withdrawal and the circumstances related thereto.111 The company is also to notify any attorney retained or employed to replace the withdrawing attorney that the previous attorney has withdrawn, ceased to participate or assist or has been discharged.112 The status of this proposal is unclear. It is worth noting that as revised this rule, while perhaps still is effective in alerting
107. Id. 108. Id. R. 205.3(d)(2). 109. 68 Fed. Reg. 6324-6325 (Feb. 6, 2003). 110. Id. at 6325; Charles M. Carberry, Lawyers under ScrutinyA Continuing Trend in the New Regulatory Environment, A.B.A. National Institute on White Collar Crime app. H-1, H-4 (2004) (course materials). 111. Proposed Rule 205.3(e), 68 Fed. Reg. 6336 (Feb. 6, 2003) provided: Where an attorney has provided an issuer with a written notice pursuant to paragraph (d)(1), (d)(2) or (d)(3) of this section, the issuer shall, within two business days of receipt of such written notice, report such notice and the circumstances related thereto on Form 8-K, 20-F, or 40-F ( 249.308, 220f or 240f of this chapter), as applicable. 112. Proposed Rule 205.3(d)(4), 68 Fed. Reg. 6335 (Feb. 6, 2003), provides in full: The issuers chief legal officer (or the equivalent thereof) shall notify any attorney retained or employed to replace an attorney who has given notice to an issuer pursuant to paragraph (d)(1), (d)(2) or (d)(3) of this section that the previous attorney has withdrawn, ceased to participate or assist or has been discharged, as the case may be, pursuant to the provisions of this paragraph.

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

299

regulators to an internal problem, raises the same concerns as its predecessor. 2. United States Sentencing Commissions Amendments to the Sentencing Guidelines As noted supra, Sarbanes-Oxley directed the U.S. Sentencing Commission to review the sentencing guidelines to ensure that they adequately deterred, prevented, and punished serious fraud offenses.113 In April 2004, the Commission approved amendments to the guidelines that: (1) increased the guideline range for obstruction of justice, (2) increased the guideline range for fraud offenses, and (3) added additional factors for consideration when assessing an organizations sentence. Unless Congress rejects these amendments, they go into effect in November 2004. a. Increased Range for Obstruction of Justice Offenses Sarbanes-Oxley directed the Sentencing Commission to review the guidelines for obstruction of justice offenses that involve more than minimal planning or abuse of a special skill or a position of trust, or where the evidence destroyed or altered was particularly probative or essential.114 Upon review, the Sentencing Commission increased the base offense level for obstruction of justice offenses and added a two-level enhancement whenever the offense involves the destruction, alteration, or fabrication of a substantial number of records, documents, or tangible objects.115 Increasing base level offense for obstruction of justice offenses is a significant step because of an apparent new trend in federal prosecutions. Rather than prosecuting defendants for underlying crimes, such as insider trading,
113. Sarbanes-Oxley, Pub. L. No. 107-204 905 (2002) 905; see also id. 805. 114. Id. 805(a); cf. id. 1104. 115. U.S.S.G. 2J1.2(b).

BUCYMACRO.DOC

2/9/2005 3:34 PM

300

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

DOJ increasingly is prosecuting defendants on obstruction of justice charges for lying to investigators during the investigations of such crimes.116 The recent prosecutions of Martha Stewart117 and Frank Quattrone118 demonstrate this trend. In both cases, federal prosecutors elected not to charge the more difficult to prove substantive offenses, opting instead to charge obstruction of justice because of the defendants misstatements to investigators during the investigation of the substantive offenses. As the one news headline recently proclaimed, Its the Cover-Up, Not the Crime.119 From the prosecutions point of view, opting to prosecute for obstruction of justice instead of the substantive offense is an effective strategy. The prosecution sends a powerful message (dont lie to investigators). Also, given the straightforward conduct (lying) and intent revealed when a defendant lies, obstruction of justice is often easier to prove than the more complex, underlying crimes.120 This trend by prosecutions makes the revised base level offense for obstruction of justice all the more significant.

116. Russell Hayman, A General Counsels Guide to Avoiding Obstruction of Justice Liability, Mondaq Bus. Briefing, 2004 WL 69983490 (June 9, 2004) [hereinafter Hayman, Obstruction of Justice]. 117. On March 6, 2004, Martha Stewart was convicted after a jury trial, of obstruction of justice charges for giving false information to federal investigators and attorneys during an investigation of whether Stewart received inside information before selling Imclone stock in December, 2001. See, e.g., Kara Scannell, Stewart Trial: White Collar, White Heat, Wall St. J., Jan. 16, 2004, at C1. 118. On May 6, 2004, Frank Quattrone, a former star investment banker in Silicon Valley, was convicted by a jury of obstruction of justice and witness tampering charges arising from an email Quattrone sent to his colleagues directing them to clean up their files during a federal investigation into how initial public stock offerings were allocated. See, e.g., Kara Scannell & Randall Smith, Round 2 for Quattrone, in Post-Tyco World, Wall St. J., Apr. 8, 2004, at C1. 119. Peter Anderson, Its the Cover-Up, Not the Crime, Triangle Bus. J., June 7, 2004. 120. Hayman, Obstruction of Justice, supra note 116.

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS b. Increased Range for Fraud Offenses

301

Sarbanes-Oxley directs the Sentencing Commission to review the sentencing guidelines for: fraud offense[s] that endanger the solvency or financial security of a substantial number of victims;121 serious fraud offenses;122 securities and accounting fraud and related offenses;123 officers or directors of publicly traded corporations who commit fraud and related offenses;124 fraud offense[s] when the number of victims adversely involved is significantly greater than 50;125 to ensure that the guidelines adequately reflect the serious nature126 of the offenses and deter, prevent and punish In November 2003, the U.S. Sentencing them.127 Commission128 amended the guidelines for crimes of fraud and deceit by increasing the base level offenses for all economic crimes;129 added two additional categories to the loss amounts (the amended, highest loss category is $400 million, rather than $100 million);130 and added new enhancements. A six-level sentence enhancement now applies for offenses involving 250 or more victims131 and a four-level enhancement applies to offenses that endanger the solvency or financial security of a publicly traded
121. Sarbanes-Oxley, Pub. L. No. 107-204 805(a)(4) (2002). 122. Id. 905(b)(1). 123. Id. 1104(a)(1). 124. Id. 1104(a)(2). 125. Id. 1104(b)(5). 126. Id. 1104(b)(1). 127. Id. 905(b)(1). 128. For an excellent overview of the Sentencing Commissions response to Sarbanes-Oxley, see Kirby D. Behre & Rachel S. Martin, Sentencing Guidelines for White Collar Defendants: Major Changes, New Climate, A.B.A. National Institute on White Collar Crime app. I-1 (2004) (course materials); John R. Steer, The Sentencing Commissions Implementation of Sarbanes-Oxley, A.B.A. National Institute on White Collar Crime app. F-17 (2004) (course materials). 129. U.S.S.G. 2B1.1. 130. U.S.S.G. 2B1.1(b). 131. U.S.S.G. 2B1.1(b)(2)(C).

BUCYMACRO.DOC

2/9/2005 3:34 PM

302

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

company.132 A four-level enhancement now applies for offenses committed by officers or directors of publicly The practical impact of these traded companies.133 enhancements is expected to be substantial134 and draconian.135 c. Amendments to Organizational Sentencing Guidelines In 1986, the Sentencing Commission began drafting sentencing guidelines for organizations; the Guidelines went into effect in 1991 and have been amended multiple times since. The organizational guidelines apply to corporations, partnerships, labor unions, pension funds, trusts, nonprofit entities, and governmental units.136 The guidelines require an organization to remedy the harm caused by its conduct and set the punishment to fit the seriousness of the offense and culpability of the organization.137 An organizations culpability is determined by its involvement in, tolerance of, or wilful ignorance of criminal activity by individuals with management authority within the organization; prior regulatory or criminal activity; violation of an order; obstruction of justice during the investigation; existence of an effective corporate compliance plan; and acceptance of 138 Since promulgated, the organizational responsibility. sentencing guidelines have provided for mitigation of an organizations sentence if the organization had in place an effective corporate compliance plan and if the organization promptly reported the wrongdoing to authorities.139 The
132. U.S.S.G. 2B1.1(b)(12)(B). 133. U.S.S.G. 2B1.1(b)(14). 134. Michael E. Clark, How Low Can You Go? (Federal Sentencing Guidelines and Criminal and Civil Damages), A.B.A. Health Care Fraud Institute app. H-15 (2004). 135. Id. app. H-18. 136. U.S.S.G. ch. 8, 8A1.1, cmt. 137. U.S.S.G. ch. 8, Introductory cmt. 138. Id. 139. Id.

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

303

amendments issued by the Sentencing Commission pursuant to Congresss directive in Sarbanes-Oxley address these areas of mitigation, primarily corporate compliance plans and the duty to report the wrongdoing to regulators. These amendments take effect in November 2004 unless Congress intervenes. (1) Guidelines Addressing Corporate Compliance Plans The 2003 amendments to the U.S. Sentencing Guidelines add section 8B2.1, which provides that an organization is deemed to have an effective compliance and ethics program only if the organization exercise[s] due diligence to prevent and detect criminal conduct and otherwise promote[s] an organizational culture that encourages a commitment to compliance with the law.140 The Guidelines set forth seven minimum requirements for such a program.141 Consistent with other efforts to encourage disclosure of wrongdoing, the amendments to the Organizational Guidelines remove the possibility of obtaining a reduction of sentence for implementation of an effective corporate compliance plan if an organization unreasonably delayed reporting an offense to regulators.142 The amendments also create a rebuttable presumption that an organization did not have an effective corporate compliance plan if high level personnel or personnel with substantial authority were involved in the offense.143

140. U.S.S.G. 8B2.1(a). 141. U.S.S.G. 8B2.1(b). These requirements previously were set forth in the Guidelines commentary. The 2003 amendments elevate them to Guideline status. 142. U.S.S.G. 8C2.5(f)(2). 143. U.S.S.G. 8C2.5(f)(3).

BUCYMACRO.DOC

2/9/2005 3:34 PM

304

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

(2) Guidelines Regarding an Organizations Reporting Requirement In addition to the prohibition noted supra that disqualifies an organization from obtaining reduction in sentence if it unreasonably delayed reporting an offense to regulators,144 new commentary to the guidelines requires waiver of attorney-client and work product privileges as part of the reporting obligation whenever such waiver is necessary in order to provide timely and thorough disclosure of all pertinent information known to the organization.145 Thus, like DOJs internal policy (the Thompson Memo) and the ABAs Amendment to the Model Rules of Professional Responsibility, the Sentencing Guidelines put pressure on counsel and clients to waive attorney-client privilege and self report. D. Recent Initiatives Association by the American Bar

In 2003, the American Bar Association amended two Model Rules of Professional Conduct. Both amendments address disclosure of client confidences. Although the amendments are permissive in allowing greater disclosure, one wonders whether they impose new standards of competency on counsel, so that realistically all corporate counsel will be expected to disclose client confidences. Prior to the 2003 amendments, ABA Model Rule 1.6 permitted counsel to reveal client confidences when counsel reasonably believes such disclosure is necessary to prevent reasonably certain death or substantial bodily harm.146 As amended, Rule 1.6 permits disclosure when counsel reasonably believes such disclosure is necessary to prevent . . . a crime or fraud that is reasonably certain to result in substantial injury to the financial interests or

144. See text accompanying supra notes 141-143. 145. U.S.S.G. cmt. to 8C2.5, n.12. 146. Model Rules of Profl Conduct R. 1.6 (b)(1) (2004).

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

305

property of another.147 Obviously, this amendment is targeted at and will affect economic wrongdoing. Professional Rule of Conduct 1.13 was also amended in 2003. Prior to amendment, Model Rule 1.13 required a lawyer who represents an organization and who knows that an officer or employee of the organization has, is currently, or is about to violate the law or any legal obligation, to proceed as reasonably necessary in the best interest of the organization.148 Model Rule 1.13 listed optional measures counsel may consider, including asking for reconsideration of the matter, seeking another legal opinion, or referring the matter to higher authority in the organization.149 Thus, under the prior rule, reporting up the ladder was only one option provided. As amended, Model Rule 1.13 now provides that reporting up the ladder by reporting wrongdoing as high as necessary through an organization is the only course of action available to counsel.150 In addition, even if the triggering events for reporting up the ladder are not met (i.e., counsel knows of a violation and is proceeding as reasonably necessary in the best interest of the organization), counsel may still report all the way up the ladder if counsel reasonably believes that she has been discharged because of her reporting up actions. In this situation counsel is permitted to proceed as she believes is reasonably
147. Id. R. 1.6. As amended Model Rule 1.6 also permits disclosure to prevent, mitigate or rectify substantial injury to the financial interests or property of another . . . Potentially, this latter provision is enormously broad, permitting disclosure years after a fraud if the disclosure is necessary to mitigate or rectify the financial injury. 148. Model Rules of Profl Conduct R. 1.13(b) (2004). 149. Id. 150. As amended, Model Rule 1.13 states: Unless the lawyer reasonably believes that it is not necessary in the best interest of the organization to do so, the lawyer shall refer the matter to a higher authority in the organization, including, if warranted by the circumstances, to the highest authority that can act on behalf of the organization as determined by applicable law. Although the rule provides an exception to the reporting up requirement: when lawyer reasonably believes that it is not necessary, as one commentator opined: It would be a brave lawyer indeed who would avail herself of that exception. Litt, Changing Contours, supra note 102, app. C-9.

BUCYMACRO.DOC

2/9/2005 3:34 PM

306

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

necessary to assure that the organizations highest authority is informed of the lawyers discharge or withdrawal.151 Prior to the 2003 amendment, Model Rule 1.13 was silent as to what counsel could or should do if counsels reporting or other steps failed to adequately address the problem. As amended, Model Rule 1.13 addresses this situation, permitting disclosure by counsel to outside sources if the organization fails to address the problem in a timely and appropriate manner152 after counsel has reported up the ladder and if counsel reasonably believes that such disclosure is necessary to prevent substantial injury to the organization.153 In a significant exception, amended Model Rule 1.13 exempts from its reporting up requirements and disclosure options lawyers who are retained by an organization to do an internal investigation.154 III. THE TWO PATHS CHOSEN BY THE RECENT REGULATORY INITIATIVES AIMED AT CORPORATE CORRUPTION The single goal of each of the regulatory initiatives enacted in the wake of recent corporate scandals is enhanced corporate integrity. All of the regulatory initiatives reviewed herein seek to accomplish this goal in one of two ways: enlisting corporate insiders as informers, and increasing the severity of consequences for those who engage in corporate wrongdoing. Part two of this article discusses how the reforms follow these paths. A. Path One: Drafting Insiders Who Know What Is Going On Portions of Sarbanes-Oxley, the Feeney Amendment to the PROTECT Act, the Thompson Memo, the SECs Rule 205, the amended U.S. Sentencing Guidelines, and the
151. 152. 153. 154. Model Rules of Profl Conduct R. 1.13(e). Id. R. 1.13(c)(1). Id. R. 1.13(c). Id. R. 1.13(d).

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

307

recent amendments by the ABA to the Rules of Professional Conduct require insiders to assist regulators. Four provisions of Sarbanes-Oxley seek to conscript insiders into the regulatory effort. Most obvious is 1350, which imposes a new duty on CEOs and CFOs, that they must certify that financial reports filed with the SEC fairly present the financial condition of the company.155 Sections 1513(e)156 and 1514A157 of Sarbanes-Oxley recognize the value of enlisting the support of insiders but follow either a protection ( 1513(e)) or reward ( 1514A) approach rather than the stick approach in 1350. Section 1513(e) makes it a crime to retaliate against insiders, while 1514A provides a private cause of action to those who suffer because they blew the whistle on corporate wrongdoing. Lastly, Sarbanes-Oxley seeks to enlist insiders as regulatory assistants by directing the SEC to set new standards for professionals who practice before the SEC.158 In response the SEC promulgated rules which impose additional duties on corporate insiders to blow the whistle internally.159 The Feeney Amendment to the PROTECT Act seeks to conscript insiders as regulatory assistants with the stick approach by restricting the ways convicted defendants obtain mitigation of their sentences to instances where defendants have assisted law enforcement.160 The U.S. Organizational Sentencing Guidelines use the carrot approach to encourage cooperation with law enforcement by providing for more lenient sentences for those organizations that cooperate with law enforcement. The 2003 amendments to the Guidelines require greater cooperation than ever for those organizations that want to qualify for mitigation of their criminal sentences. The amendments require that an organization must report its

155. 156. 157. 158. 159. 160.

18 U.S.C. 1350. 18 U.S.C. 1513(e). 18 U.S.C. 1514A. Sarbanes-Oxley, Pub. L. No. 107-204 307 (2002). 17 C.F.R. 205 (2003). Pub. L. No. 108-21 401(m), 18 U.S.C. 3553.

BUCYMACRO.DOC

2/9/2005 3:34 PM

308

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

wrongdoing to regulators without unreasonable delay[].161 Thus, in-house counsel must quickly determine if an internal investigation into the alleged wrongdoing is necessary, who should do the investigation, and whether outside counsel should be retained. Counsel conducting the investigation must determine the scope and extent of the investigation, conduct the investigation, and determine what disclosure, if any, should be made to regulators.162 Because of high stakes (possible prison terms for corporate officers and directors, severe sanctions for the organization) and complexity of most corporate wrongdoing, the no unreasonable delay mandate increases the institutional and personal stress for all involved. The 2002 amendments to the U.S. Sentencing Guidelines also require that more information be given to regulators than in the past. Essentially, they require that an organization must reveal who was involved in the wrongdoing and to what extent. Granted, the Guidelines do not explicitly require such disclosure but do so implicitly by creating a rebuttable presumption that if high level personnel or personnel with substantial authority were involved in the offense, the organization did not have an effective corporate compliance plan.163 Implementation of an effective corporate compliance plan is a significant factor in assessing an organizations sentence upon conviction. To rebut this presumption or deal with it if it does apply, an organization must identify to regulators the individuals within the organization who are responsible for the wrongdoing and the extent of their involvement. It is important to note that the Department of Justices directive to prosecutors contained in the Thompson Memo regarding factors to consider in determining whether to charge an organization with a crime also requires organizations to determine and identify those who were involved in the wrongdoing.164
161. U.S.S.G. 8C2.5(f)(2). 162. Robert Fabrikant, Paul E. Kalb, Mark D. Hopson, & Pamela H. Bucy, Health Care Fraud: Enforcement and Compliance 8.01-8.12 (2004). 163. U.S.S.G. 8C2.5(f)(3). 164. Thompson Memorandum, supra note 15.

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

309

The 2002 amendments to the U.S. Sentencing Guidelines require waiver of privileged information by organizations that want credit for cooperating with law enforcement.165 Commentary in the 2002 amendments to the Guidelines states that waiver of the attorney-client and work-product privileges by an organization is required whenever necessary for full disclosure of all pertinent information known by the organization about the Although theoretically possible for an wrongdoing.166 organization to make a full disclosure without waiving privileged information, it is hard to imagine, especially when an internal investigation has been conducted. Here too, the expectation that an organization must waive its attorney-client and work-product privileges to receive credit for cooperation is echoed by the Department of Justice internal policy. The Thompson Memo states that an organizations willingness to waive attorney-client and work-product privileges is relevant to the prosecutorial decision whether to charge an organization with a crime.167 The last reform that is designed to enlist insiders as law enforcements eyes and ears is the ABAs amendments to the Rules of Professional Conduct. Amended Rule 1.6 expands the circumstances under which counsel may breach client confidence to instances where counsel has been consulted in connection with a financial crime.168 Previously, counsel was permitted to reveal a client confidence only when counsels advice had been sought to conduct a crime involving death or substantial bodily harm.169 Amended Rule 1.13 imposes new reporting duties on lawyers who work in an organization to report wrongdoing. Under prior Rule 1.13, an attorney had several options of what to do upon discovering wrongdoing, but now counsel is required to report suspected wrongdoing

165. 166. 167. 168. 169.

U.S.S.G. cmt. to 8C2.5 n.12. Id. Thompson Memorandum, supra note 15. Model Rules of Profl Conduct R. 1.6 (2004). Model Rules of Profl Conduct R. 1.6 (2002).

BUCYMACRO.DOC

2/9/2005 3:34 PM

310

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

up the ladder within the organization.170 SEC Rule 205, promulgated pursuant to Sarbanes-Oxleys mandate that the SEC devise standards of conduct for those who practice before it, also requires that insiders (not just attorneys, but anyone who appears and practices before the Commission) report up the ladder through the organization information about wrongdoing.171 In summary, both of the legislative initiatives (Sarbanes-Oxley and the Feeney Amendment), the executive branchs initiative (the Thompson Memo), both of the administrative agency initiatives (the SECs Rule 205 and the U.S. Sentencing Commissions amendments to the Sentencing Guidelines), and the ABAs amendments to the Professional Rules seek to draft insiders to regulatorss efforts. B. Path Two: Bad Things Happen to Insiders Who Dont Assist Law Enforcement The second path chosen by the corporate integrity initiatives is imposing unpleasant consequences on those who engage in corporate wrongdoing and in some cases on those who fail to report it. These consequences range from prison to peer pressure. Sarbanes-Oxleys new crimes and stiff sentences, the Feeney Amendments restriction in obtaining downward departures, DOJ internal policies on the exercise of prosecutorial discretion (both the Thompson Memo and the Ashcroft Memo) and the 2003 amendments to the U.S. Sentencing Guidelines increase in sentences make it more likely that corporate wrongdoers as well as insiders who fail to fulfill their legal obligations will go to prison. When evaluating the impact of these new crimes and stiffer sentences, it is important to bear in mind two general principles of criminal jurisprudence: accomplice liability and conspiracy liability. Both render actors on the

170. 17 C.F.R. 205. 171. Id.

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

311

periphery of crimes criminally liable for the crimes. A person is guilty as an accomplice to a crime if she intends for the principal actor to commit a crime, knows the principal is or is planning to commit a crime, and renders assistance to the principal in committing the crime.172 There need not be an agreement between the principal and aider; the principal actor need not even know of the aiders assistance. A well known case, State v. Tally,173 demonstrates this. William Talley prevented a warning from being sent to an intended murder victim, thereby allowing Talleys relatives to ambush and kill the victim.174 There was no evidence that Talleys relatives (the ambushers) knew of, or requested help from Talley.175 Even so, Talley was found guilty of murder as an accomplice. The court reasoned that because of the assistance he intentionally rendered, Talley was just as guilty as those who shot and killed the victim.176 Applying complicity principles to the corporate context means that if a corporate executive knows that her colleagues are misrepresenting the financial condition of a corporation and she aids them by not reporting the misrepresentation to auditors, the executive is guilty of the same offenses as those directly involved. It does not matter why the executive did not alert auditors. Nor is it irrelevant to the executives liability whether her colleagues were aware of her help to them; she is guilty even if they never knew of her assistance. Conspiracy liability is broader than complicity liability because it makes it a crime to engage in extremely preliminary criminal conduct. Simply agreeing to do a crime is a conspiracy, even if no steps are taken to commit the offense.177 The agreement may be tacit or overt, and

172. Sarah N. Welling, Sara Sun Beale, & Pamela H. Bucy, Federal Criminal Law and Related Actions 4.2 (1998). 173. 15 So. 722 (Ala. 1894). 174. Id. at 724-25. 175. Id. at 727. 176. Id. at 741. 177. Pamela H. Bucy, White Collar Crime, Cases and Materials 5-6 (1998).

BUCYMACRO.DOC

2/9/2005 3:34 PM

312

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

may be proven by direct or circumstantial evidence.178 Under conspiracy liability, the executive who learns that others within the corporation are misrepresenting the financial condition of the corporation and does nothing to stop or report the misrepresentations may be a coconspirator if a tacit agreement can be found to exist among the actors. It does not matter if none of the actors took any steps to execute the crime. All that is necessary is an agreement, an intent that one conspirator commit the crime, and evidence of the agreement. Unlike complicity liability, it is not even necessary that this actor assist the perpetrators in any way. Sarbanes-Oxleys new crimes and stiffer sentences carry even more of a bite when viewed in the context of broad principles of conspiracy and complicity liability and in conjunction with the Feeney Amendment to the PROTECT Act and the amendments to the U.S. Sentencing Guidelines, which affect the sentences convicted defendants receive. Although they do not carry as big of a stick, the SECs up-the-ladder rule and the ABAs amendments to the Rules of Professional Conduct bring pain to insiders who do not fulfill their new duties of reporting wrongdoing to regulators. The stick approach of imposing unpleasant consequences on those who engage in wrongdoing has the potential to effectively deter wrongdoing. Not only is the likelihood of being prosecuted and going to jail extremely unpleasant, it is also public. Very public. Once a corporate executive is prosecuted, her name appears on court documents and in newspaper headlines. Perp walks flash her arrest spectacle for all to see. Defending against criminal prosecution can be financially disastrous. Conviction likely will result in painful and publicly visible changes in lifestyle for the offender and her family. Because of their powerful communicative ability, the stick

178. Pamela H. Bucy, Information as a Commodity in the Regulatory World, 39 Hous. L. Rev. 940-47 (2002) [hereinafter Bucy, Information As a Commodity].

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

313

approach of the recent regulatory initiatives may affect the norm of what is now expected of a competent corporate executive. Together, these initiatives communicate that no longer should corporate executives close ranks, protect themselves, their employer, friends, and colleagues by covering up improper conduct. Rather, corporate executives today should be alert for wrongdoing, blow the whistle when they see it. Above all, they should report, report, report. IV. WILL THE REGULATORY INITIATIVES WORK? A. Reasons To Think the Reforms Will Work There are five reasons to believe that the regulatory reforms enacted post-Enron will be effective in detecting and deterring corporate wrongdoing. First and foremost, they recognize the benefit of insiders information and make efforts to enlist such information. Complex economic wrongdoing cannot be detected or deterred effectively without the help of those who are intimately familiar with it. Such wrongdoing usually is concealed from its victims, buried in documents and diffused within an organization. It is virtually impossible for anyone outside the group of perpetrators to know what is going on, until it is too late and losses are sustained. Knowledgeable insiders who can provide regulators with specific information about who, what, where, and why corporate wrongdoing is taking place are an invaluable resource for regulators. Without this information, regulators are condemned to playing catch up, never fully learning what went on and expending large amounts of resources in scattershot efforts to do so.179 The second reason the regulatory reforms enacted post-Enron may be effective is that they recognize the difficulty of what they demand of insiders and take steps to overcome the difficulty. Rarely will insiders want to aid regulators. It is personally wrenching to turn in friends,
179. Bucy, Information As a Commodity, supra note 178.

BUCYMACRO.DOC

2/9/2005 3:34 PM

314

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

colleagues, sometimes even family. Insiders also may incur enormous professional costs for providing information to regulators.180 Surveys of whistleblowers consistently show the hardship they endure. In one survey of ninety whistleblowers, 54 percent said they were harassed at work, 82 percent said they were harassed by superiors, 80 percent reported physical deterioration as a result of their whistleblowing experience, and 86 percent reported negative emotional consequences, including feelings of depression, powerlessness, isolation, anxiety and anger.181 The recent reforms recognize the difficulty of asking insiders to turn in friends. They seek to overcome the powerful disincentives to doing so by applying a stick approach. The reforms expand criminal liability and impose severe penalties on insiders who fail to cooperate. Insiders who should be aware of corporate wrongdoing but arent violate 1350, a ten-year felony, under Sarbanes Oxley. Insiders who are attorneys and who fail to report perceived wrongdoing violate ethical standards imposed by the ABA. Insiders who practice before the SEC and fail to report up the ladder face sanctions. Organizations are subject to more aggressive prosecution and stiffer sentences if they fail to assist regulators by fully investigating and disclosing, in depth, who, what, when, and how wrongdoing took place. Corporate executives now face new norms of competency, which subject them to greater shareholder liability as well as action by regulators. At all levels, regulators are more focused on corporate corruption and more likely to aggressively exercise their prosecutorial discretion against those who commit, tolerate, aid, or intentionally ignore such activity. The third reason the post-Enron reforms may be effective in detecting and deterring corporate wrongdoing is that they elevate corporate wrongdoing to the top of prosecutive agendas.182 This, in turn, leads to added
180. Id. at 948-58. 181. Clyde H. Farnsworth, Survey of WhistleBlowers Finds Some Retaliation but Few Regrests, Chi. Daily L. Bull., July 27, 1987, at 3. 182. Michael Bologna, Lawyers Cite Tougher Stance on White Collar

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

315

resources.183 Such prioritization may, of course, be shortlived, giving way to other priorities as future dramas and crises capture government attention. While in place, however, agenda priorities are powerful. Wrongdoing that may not have been investigated previously will be. That alone has deterrent value. In addition, however, exercises of prosecutive discretion will tilt toward aggressive deployment of broad statutes and existing principles of liability. The fourth reason the post-Enron reforms may be effective is that they focus the publics attention on the importance of detecting and deterring corporate wrongdoing. Although subtle and difficult to gauge, this increased sensitivity could make a difference. Individuals may be more vigilant to what is going on around them and more empowered to blow the whistle. Witnesses may be more willing to be forthright and candid. Shareholders may be more aggressive in bringing suits based upon lack of due diligence by corporate executives. Executives may be more careful to avoid wrongdoing. Judges may be tougher on corporations that come before them. The last reason the post-Enron reforms may be effective is related to the prior reason. Their collective influence may be altering norms of behavior in the business world. No longer will companies and corporate executives be expected to generate as much profit as possible in whatever way possible. Instead, they will be expected to generate as much profit as possible while being honest. B. Reasons to Think the Reforms Will Not Work There are two reasons to question whether the reforms will achieve their goal of detecting and deterring corporate wrongdoing. First, they impose a costly infrastructure on American businesses. For companies barely operating at a profit, and for companies that compete in the global market, these costs may cause severe hardship.184
Enforcement Efforts, Sec. Reg. & L. Rep., May 10, 2004, at 856. 183. John R. Schmidt, Ready for Prosecutors, Legal Times, Oct. 7, 2002, at 35. 184. Tamara Loomis, For Public Companies, A High Price for Compliance,

BUCYMACRO.DOC

2/9/2005 3:34 PM

316

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

Second, the conventional wisdom shared by the reformsthat the way to alter behavior is to impose harsh consequences for those who engage in itmay be wrong. Clearly, the key to the reforms effectiveness is their ability to marshal the valuable resource of inside information. If they fail in this regard they fail in their goal of better detection and deterrence of corporate wrongdoing. Raising the stakes for those who engage in corporate wrongdoing may be counterproductive in obtaining this inside information in three respects. First, those who fear prosecution may be so concerned about their liability or that of their friends that they communicate less with corporate counsel. They do not want corporate counsel, now regulators in-house surrogate, to report them. In addition, corporate executives who are not concerned about their own liability may opt not to communicate with corporate counsel because they dont want to be told no. In the post-Enron world, corporate counsel is and should be cautious. In the business world, aggressive, pushing-the-envelope tactics often are the key to success. Executives who want to pursue aggressive tactics simply wont consult with counsel about them because they dont want to be hemmed in by corporate counsels caution. Third, corporate counsel, and any other insiders with an obligation to report perceived wrongdoing, may have their own motive for poor communication with corporate executives. They dont want to have to report them if they learn of wrongdoing. This reluctance is a function of the carpool factor. Almost certainly corporate counsel will be social friends with many executives within the organization. They will belong to the same community and social organizations, their children may attend school and extracurricular activities together, and their families probably carpool together. Once corporate counsel or any insider knows of anothers wrongdoing, it is painful, personally and professionally, to alert regulators and set in motion events that could ruin his friends lives.185 Added to

Natl L.J., May 12, 2003, at 18. 185. Bucy, Information as a Commodity, supra note 178, at 948-58.

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

317

this is the professional ostracization whistleblowers are likely to face. Companies, even an entire industry, could boycott a whistleblower; after all, who wants to run the risk of having the whistle blown on him?186 The question is whether something besides the stick approach would be more effective in deterring and detecting corporate wrongdoing. Fisch & Rosen have suggested several ideas which increase the incentives for corporate decisionmakers to demand information from their lawyers. They suggest requiring additional personal certifications of accuracy on reports filed with the SEC, increased liability for directors, greater use of outside counsel to investigate possible problems within the corporation, and greater use of the legal audit committee.187

186. Id. 187. Fisch and Rosen have noted the following possible problems. Jill E. Fisch & Kenneth M. Rosen, Is There a Role For Lawyers in Preventing Future Enrons?, 48 Vill. L. Rev. 1097 (2003). Getting information of wrongdoing to the board of directors is only that; there is not way to ensure that once the board has the information it will take appropriate action. In fact, it appears that the Enron board had adequate information of malfeasance but repeatedly failed to respond appropriately. Id. at 1118-19. Fisch and Rosen argue persuasively that imposing reporting obligations on counsel is a second-best option for detecting and deterring corporate wrongdoing and that the best solution is to encourage directors to better govern corporate actions and culture. Id. at 1131-38. They suggest the following to more directly impact directors behavior: additional personal certifications of the contents of corporate communications and reports, id. at 1132-33; increased civil and criminal liability for directors, id. at 1133-34; creation of a legal audit committee of the board, id. at 1135-37, that would include routine, more inclusive reporting by corporate counsel to the board, id. at 1136; and greater use of outside counsel to investigate possible problems, id. at 1135. Second, the reporting requirement ignores the fact that attorneys and law firms compete for corporate clients. Businesses may well prefer counsel who does not often see a need to report suspected wrongdoing than counsel who takes seriously the reporting up requirement. Id. at 1123-24. Third, the reporting up requirement ignores the fact that it is likely to be personally difficult for counsel to report on corporate executives who have been and are personal friends. A related concern is counsels professional reputation. Few businesses will be eager to hire a known whistleblower. Fifth, the reporting up requirement jeopardizes the sense of trust that needs to exist between clients and counsel for clients to feel comfortable fully disclosing possible problems. Id. at 1125-26.

BUCYMACRO.DOC

2/9/2005 3:34 PM

318

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

C. A Helpful Option There is an additional regulatory tool to add to the package of reforms: a carrot that entices insiders to bring regulators information of corporate wrongdoing. For this tool to be helpful two things are needed: enactment of a qui tam provision, similar to the civil False Claims Act, and reduction of the draconian criminal penalties applicable to corporate wrongdoers because of SarbanesOxley, amended U.S. Sentencing Guidelines, and new DOJ policies. The tastiest carrot in the world will not be able to bring forth enough inside information where the consequences for perpetrators are so severe. Crafting a qui tam provision for use in the financial world would not be difficult. There is enough experience with this mechanism in the false claims context to see how it could be deployed effectively in the financial context. Briefly here is how the qui tam model works in the federal contracting area: A person who believes that he has information that someone else (individual or company) has filed false claims with the federal government may file a lawsuit making such allegations.188 This plaintiff (termed a relator) is required to file his lawsuit under seal (not even serving it on the defendant). The relator is also required to give a copy of his lawsuit to the United States Department of Justice (DOJ), along with a written report of all material evidence and information the relator possesses.189 The lawsuit remains under seal, often for two years or more, to allow the DOJ to fully investigate charges made by the relator.190 The secrecy of the sealed complaint not only facilitates the DOJs investigation of the relators information191 but also protects a defendants reputation if the relators information amounts to nothing.192

188. 31 U.S.C. 3730(b)(1)(2004). 189. Id. 3730(b)(2). 190. Robin Page West, Advising the Qui Tam Whistleblower 33 (2000). 191. Interview with John R. Phillips, then Co-Director, Center for Law in the Public Interest, Corp. Crime Rptr., Nov. 9, 1987, at 11. Phillips, who is generally credited as the person responsible for the 1986 Amendments to the FCA,

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

319

At the conclusion of its investigation, the DOJ decides whether it will intervene in the lawsuit as an additional plaintiff. If it does, the DOJ assumes primary responsibility for the case, although the relator remains as a plaintiff and is guaranteed a participatory role.193 In some cases, the DOJ handles the entire case after intervening; in others, relators work hand in hand with government prosecutors. In some cases, relators and their attorneys assume the bulk of the investigative and litigative duties.194 If the DOJ does not join the lawsuit, the relator may continue, litigating the case alone.195 Even if the DOJ does not join a relators case, it retains authority over the relators lawsuit in several ways: the DOJ monitors the case and, with a courts consent, may join it at any time, even for limited purposes, such as appeal;196 the DOJ may settle or dismiss a relators suit over the relators objections as long as the relator has been given an opportunity in
explained how the sealing provision came about: The Justice Department resisted these qui tam provisions of the False Claims Act. If you look at the record, the Justice Department didnt want them changed at all. One argument that was advanced was, you are going to make our job more difficult because as soon as you file these complaints, it is public information, and we cant do our normal investigations. If we want to put a wire on somebody or do an undercover investigation, you have blown the cover instantly, so this is a bad idea. My response was to say, fine, we will draft a seal provision so that it is under seal until you decide to join the case. . . . It is a very unusual provision in that regard. What [it] did was [to] completely negate the argument advanced by the Justice Department. See, e.g., West, Advising the Whistleblower, supra note 190, at 33; Sen. Rep.99345, reprinted in 1986 U.S.C.C.A.N. 5266, 5281. 192. Bucy, Private Justice, supra note 1. 193. 31 U.S.C. 3730(c)(1)(2004). 194. For other examples of FCA qui tam cases where the relator and relators counsel assumed large amounts of responsibility for the preparation of the case, see United States ex rel. Alderson v. Quorum Health Group, Inc., 171 F. Supp. 2d 1323 (M.D. Fla. 2001); United States ex rel. Merena v. SmithKline Beecham Corp., 114 F. Supp. 2d 352 (E.D. Pa. 2000) (facts more fully discussed in Merena, 52 F. Supp. 2d 420 (E.D. Pa. 1998) revd 205 F.3d 97 (3rd Cir. 2000)). 195. 31 U.S.C. 3730(c)(3) (2003). 196. Id. 3730(c)(3)(2003); See, e.g.,Vermont Agency of Natural Resources v. United States ex rel. Stevens, 529 U.S. 765, 769 (2000); United States ex rel. Garibaldi v. Orleans Parish Sch. Bd., 244 F.3d 486, 489 (5th Cir. 2001).

BUCYMACRO.DOC

2/9/2005 3:34 PM

320

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

court to be heard;197 the DOJ may seek limitations on the relators involvement in the case,198 or seek alternative remedies (such as administrative sanctions) in lieu of the relators lawsuit.199 If the government joins the relators case, the relator is guaranteed at least 15 percent of any judgment or settlement and the court can award moreup to 25 percent. If the government does not join the lawsuit, the relator is guaranteed 25 percent and could receive up to 30 percent.200 The amount within the statutory award depends upon the relators helpfulness to the government.201 Because the FCAs damages and penalty provisions tend to generate exceptionally large judgments,202 relators percentages involve substantial sums.203
197. 31 U.S.C. 3730(c)(2)(A) and (B) (2003). DOJ may even move for dismissal or oppose a settlement without intervening. See, e.g., Juliano v. Federal Asset Disposition Assn, 736 F. Supp. 348, 350-51 (1990) (DOJ moved to dismiss relators case after declining to intervene); United States v. Health Possibilities, P.S.C., 207 F.3d 335, 340-41 (6th Cir. 2000) (After declining to intervene, DOJ opposed the settlement reached by relator and defendant.). 198. 31 U.S.C. 3730(c)(2)(C) (2004). 199. Id. 3730(c)(5). 200. Id. 3730(c)(3). 201. The FCA has four built-in features to reward only those relators who actually supply helpful information. First, the FCA directs courts to determine what percentage, within the statutory range, of the judgment should be given to the relator based upon how helpful the relator was in advancing the case to litigation. 31 U.S.C. 3730(d)(1) (2004). Second, a court is directed to reduce the share of the award further if the relator planned or initiated the FCA violation, and to exclude the relator from receiving any portion of the award if she has been convicted of conduct constituting the FCA violation. Id. 3730(d)(3). Third, the FCAs jurisdictional bar provision prohibits a qui tam case from going forward if the information it includes is already public (unless the relator is the original source of the information. Id. 3730(e)(4). Lastly, the FCA provides that only the first qualifying qui tam lawsuit may proceed. Id. 3730(b)(5). 202. For example, recent judgements in FCA qui tam cases include an $875 million settlement from TAP Pharmaceuticals, 55 HealthCare Fin. Mgt. 10 (2002); a $745 million settlement with HCA Healthcare Corporation to resolve some of the alleged FCA violations pending against HCA; a $385 million settlement with National Medical Care, Inc.; a $325 million settlement with SmithKline Beecham Clinical Laboratory; a $325 million settlement with National Medical Enterprises; and a $110 million settlement with National Health Laboratories. Boese, supra note 45, 1.05[A]. 203. Recent relators awards include $95 million, $44.8 million, $28.9 million,

BUCYMACRO.DOC

2/9/2005 3:34 PM

2004]

CARROTS AND STICKS

321

The qui tam provision of the FCA contains two features that render it extraordinarily successful bringing forth inside information.204 It does so through the damages and penalty provisions and the jurisdictional bar provision.205 The damages and penalty provisions, coupled with the mandatory percentage allocated for the relator, provide a substantial enough incentive to attract knowledgeable insiders willing to serve as whistleblowers. The jurisdictional bar provision, which disqualifies most of us from serving as relators, ensures that a whistleblowers information is timely and helpful to the government. Second, the dual-plaintiff mechanism, whereby DOJ investigates, amends, joins, or monitors the private plaintiffs suit, provides a potentially powerful quality control on the private actions. It also provides a way for knowledgeable and helpful insiders to work hand in hand with regulators lending expertise and resources to an overburdened DOJ.206
and $18.1 million. Top Qui Tam Recoveries of the Year 2000, TAF Q. Rev., Jan. 2001, at 20-21. 204. This was one if its goals. As noted in the senate report accompanying the 1986 Amendments, [t]he proposed legislation seeks not only to provide the Governments law enforcers with more effective tools, but to encourage any individual knowing of Government fraud to bring that information forward. S. Rep. No. 345, 99th Cong. (1986), reprinted in 1986 U.S.C.C.A.N. 5266, 5266-67. 205. The jurisdictional bar provision provides: No court shall have jurisdiction over an action under this section based upon the public disclosure of allegations or transactions in a criminal, civil, or administrative hearing, in a congressional, administrative, or Government Accounting Office report, hearing, audit, or investigation, or from the news media, unless the action is brought by the Attorney General or the person bringing the action is an original source of the information. 31 U.S.C. 3730(e) (2004). 206. The FCA contains another mechanism to help with quality control, but this mechanism, unlike the dual-plaintiff system, is not unique to the FCA. The FCA provides that parties filing frivolous qui tam actions may be held responsible for defendants attorneys fees and expenses: If the Government does not proceed with the action and the person bringing the action conducts the action, the court may award to the defendant its reasonable attorneys fees and expenses if the defendant prevails in the action and the court finds that the claim of the person bringing the action was clearly frivolous, clearly vexatious, or brought primarily for purposes of harassment. 31 U.S.C. 3730(d)(4) (2004). See, e.g., United States ex rel. Haycock v. Hughes

BUCYMACRO.DOC

2/9/2005 3:34 PM

322

BUFFALO CRIMINAL LAW REVIEW [Vol. 8:277

The number of suits filed and monetary judgments obtained in qui tam FCA actions, especially when compared to other existing private attorney general actions, shows that the qui tam FCA private justice model is successful. Between 1987 and 2000, an average of 237.5 qui tam FCA cases were filed annually, compared to 181.8 average annual filings of securities fraud class actions and 37.4 average annual filings of environmental citizen suit private attorney general actions.207 Moreover, since 1987, there has been a sharp increase per year in qui tam FCA filings compared to relatively flat numbers of filings in securities and citizen suit private actions.208 The qui tam FCA private justice model could and should be expanded to protect national financial markets. These markets need inside information of wrongdoing. They also need the most effective regulatory tools available. The carrot approach of the qui tam mechanism in the government contracting arena has proven to be enormously successful. It should be deployed to enhance corporate integrity. CONCLUSION The confluence of post-Enron reforms by legislative, executive, administrative government actors as well as the ABA is impressive. The reforms are surprisingly coherent in their stated goal and approaches chosen to achieve their goal. Whether they will work or be derailed by unintended consequences remains to be seen. This article suggests that the intended effect of these reforms can be maximized and their unintended effects minimized by including a qui tam provision similar to that successfully used in the government contracting arena.

Aircraft Co., No. CV 90-1677 (C.D. Ca. May 9, 1994); United States ex rel. Herbert v. National Academy of Sciences, Civ. A. No. 90-2568, 1992 WL 247587 (D.D.C. 1992). 207. Bucy, Private Justice, supra note 1, apps. C-4, C-5, C-6. 208. Id. app. C-4.