by Jennifer Arlen and Marcel Kahan
Over the last decade, corporate criminal enforcement in the U.S. has undergone a dramatic transformation. Federal officials no longer simply fine publicly held firms that commit crimes. Instead, in addition to imposing a fine, prosecutors regularly use their enforcement authority to impose mandates on firms that alter their internal governance.
Prosecutors generally impose mandates through pretrial diversion agreements (PDAs), specifically deferred and non-prosecution agreements. PDAs are criminal settlements that subject the firm to sanctions without formally convicting it. In return, firms usually agree to cooperate in the investigation and admit the facts of the crime.
Most PDAs contain mandates that govern the firm’s future behavior. These mandates impose new prosecutor-created duties on the firm. They may require the firm to adopt a corporate compliance program with specified features not otherwise required by law, to alter its internal reporting structure, to add specific individuals to the board of directors, to modify certain business practices, or to hire a prosecutor-approved corporate monitor.
Prosecutors’ use of PDAs to create and impose such mandates on firms with detected misconduct fundamentally alters both the structure of corporate criminal law and the role of the prosecutor. Since the 1990s, firms have been effectively subject to duties to adopt an effective compliance program, self-report, or cooperate (hereinafter “policing duties”). These policing duties are imposed ex ante on all firms (or all firms in a particular category). Firms that fail to satisfy these policing duties risk enhanced criminal sanction, but generally only if a substantive criminal violation occurs.
PDA mandates deviate from this traditional regime in two ways. First, they impose policing duties ex post, on select firms with detected wrongdoing, instead of ex ante on all firms. Indeed, mandated duties not only are imposed after a substantive violation occurs, but the content of the mandates is often determined only at that time. Thus, firms do not know beforehand what additional duties they will become subject to should they commit a substantive violation and become subject to a PDA mandate. Second, a mere violation of the firm’s ex post policing mandate, without the commission of (another) substantive violation, exposes the firm to liability. In combination, these two features of PDA mandates transform prosecutors into firm-specific quasi-regulators. Prosecutors can impose specific duties on a subset of firms with alleged wrongdoing; and they enforce compliance with these duties through sanctions for a mere failure to comply with the duty, even if no substantive crime occurs.
Department of Justice policy and federal practice encourage prosecutors to impose PDA mandates on any firm that did not have an effective compliance program at the time of the crime. The DOJ, however, has not adopted standards governing what mandates to impose.
In a forthcoming article, we conclude that mandates should be employed far more selectively than is called for by current federal policy and practice. Federal authorities can best deter crime by employees of publicly-held firms by inducing firms to intervene to detect and report wrongdoing, and cooperate to bring the individuals responsible to justice (corporate policing). PDA mandates generally are not the optimal response to firms that fail to do so. Generally, deterrence is better served by imposing breach of generally-applicable ex ante policing duties, as occurs in the traditional corporate criminal liability regime. Such duties can be enforced either by enhanced sanctions on firms that breached their policing duties and committed a substantive wrong (harm-contingent sanctions) or by sanctions on any firm that breaches these duties even if no substantive wrong occurred (non-harm-contingent sanctions). Usually, PDA mandates, which are imposed ex post on select firms with detected wrongdoing, are neither needed nor desirable.
PDA mandates are needed only in one particular situation: when a firm’s senior managers benefit personally from deficient policing even though the firm would be better off with optimal policing. These firms are plagued by what we call “policing agency costs.” Policing agency costs arise when the firm’s senior managers or board of directors personally benefit from either wrongdoing or deficient corporate policing. In this situation, traditional corporate liability–with sanctions targeted at the firm—will not suffice to induce firms to undertake effective compliance, self-report, and cooperate. Because senior managers obtain personal benefits from deficient policing, the threat of sanctions imposed on the firm for deficient policing may not be sufficient to induce them to ensure the firm undertakes effective policing.
PDA mandates are a potentially effective solution to this problem. Properly designed PDA mandates can ameliorate policing agency costs by making it more difficult or more costly for senior managers to have the company undertake deficient policing. PDAs may be superior to regulation for imposing such measures because regulators cannot identify firms with severe policing agency costs ex ante. By contrast, prosecutors intervening ex post often can both identify firms with policing agency costs and employ information gained in the investigation to remedy the problem as a by-product of their criminal investigation.
Although identifying firms with policing agency costs inevitably requires ex post firm-specific analysis of the firm’s policing, three circumstances indicate that policing agency costs either do not explain previous deficient policing or are unlikely to be present in the future: first, when a publicly-held firm has a controlling shareholder with sufficient power and incentives to induce managers to act in the firm’s best interest; second, when senior managers responded proactively by self-reporting suspected wrongdoing before any threat of disclosure and fully cooperating; and third, when the firm underwent a transformative change, such as a change in control, that affected the previously prevailing policing agency cost structure. In these circumstances, PDA mandates are likely not warranted.
Even when a firm suffered from policing agency costs, PDA mandates are only justified to the extent that they are effectively designed to reduce these costs. To do so, PDAs should either impose precise duties falling on specific people who should expect to be held accountable for breach of these duties; or shift responsibility over policing to those not afflicted by agency costs, such as outside directors or external monitors. Mandates that are not designed to reduce policing agency costs, or mandates designed to improve corporate governance generally, rather than policing agency costs specifically, are generally inappropriate.
The DOJ thus could better help deter corporate crime, while addressing concerns that arise about the scope of prosecutorial discretion, by adopting policies directing prosecutors to impose mandates only when the firm is plagued by serious policing agency costs and providing guidance on the types of mandates that can be expected to address this problem. Broader use of mandates is not effective at deterring corporate crime and may be counter-productive.
Jennifer Arlen is the Norma Z. Paige Professor of Law and Director of the Program on Corporate Compliance and Enforcement at NYU School of Law. Marcel Kahan is the George T. Lowy Professor of Law at NYU School of Law. This post is based on their joint article, Corporate Governance Regulation Through Non-Prosecution, 84 University of Chicago Law Review (forthcoming 2017).