DPAs and Corporate Governance

DPA and Corporate Goverance in Concurring Opinions, February 10, 2013

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In this season’s law review submission process, I am circulating an article about deferred prosecution agreements (DPAs) and corporate governance.    DPAs are controversial tools increasingly-used to settle corporate criminal cases, usually without indictment. Targets admit facts, pay fines and promise governance reforms—such as replacing officers, adding directors and prescribing reporting lines.

Some view DPAs as coerced extractions of overzealous prosecutors, while others say they are mere whitewash that let corporate crooks off the hook. The weight of commentary urges prosecutors to get out of this business, to avoid corporate governance entirely, while some wonder why the intrusions are not deeper and more frequent.

I explain why prosecutors should invest in corporate governance and take a measured approach to reforming it. Ignoring governance can be perilous and embracing it can produce more effective reforms.

My diagnosis indicates a lack of both investment and transparency so I make two prescriptions: prosecutors should profile the corporate governance of businesses they target at the outset and publicly articulate rationales for reforms when settling.

The paper first surveys the landscape of contemporary corporate governance, stressing two normative points. First: one-size-does-not fit all. Corporate governance varies enormously from company to company, depending on such factors as ownership structures, management characteristics and employment policies. Second: failure to appreciate that poses serious risks, always to given companies, and sometimes to the economy at large.

That is the proper lesson to draw from the 2002 case of Arthur Andersen, where an indictment destroyed the auditing firm because it was a partnership owned and managed by its members in the veracity business.

Instead, prosecutors took a broader and cruder lesson: that they should always be averse to indicting any large business. The result of that aversion has been the proliferation of DPAs—which, despite controversy and criticism, is not necessarily a bad effect, so long as these lessons are incorporated into their production.

The paper then presents an original case study extending these normative points, here in the context of both prosecutor decisions made at the outset of an investigation, and in a DPA concluding it. The case is AIG and the ex ante problem was that prosecutors in 2005 stepped into an ongoing governance debate over CEO succession. They forced a hasty ouster of the CEO without adequate planning.  The ex post problem was that prosecutors dictated a series of standardized governance reforms off the rack without considering how they would suit AIG.  As became clear, they were ill-suited and the reforms played a causal role in putting AIG at the heart of the 2008 financial crisis.

Having suggested some of the high stakes of miscalculation and excessive standardization, the article turns to how to conceptualize and evaluate DPAs. Proponents of the status quo implicitly conceive of them as contracts with open-ended terms; critics see them as regulation, warranting limitations on their scope. In my view, both conceptions are partly right, and, therefore, both normative prescriptions are entirely wrong.

DPAs have contractual aspects. No one is obliged to enter into one. Companies differ in their responses. Terms are negotiated and the defense bar pushes back. If DPAs were pure contracts, the law of contracts would suffice to evaluate their proper scope and validity of terms. Governance terms would be as proper as any other.

Yet DPAs have regulatory qualities—government agents wielding enormous power proffer terms and violations result in public sanctions. Were they pure regulation, as many argue, their scope should be narrow given the superiority of ex ante legislation or administrative rulemaking. That would put most governance terms off limits in DPAs.

These competing conceptions of DPAs as either contracts or regulation are thus each half-truths. The halves yield to a different reality, which is that these devices are products of prosecutorial discretion. Indeed, as decisions akin to prosecutorial declinations, they are substantially insulated from judicial and legislative review—and for good reasons steeped in the separation of powers and effective administration of justice.

Given the stakes of the governance terms DPAs contain, however, prosecutors must proceed cautiously. They occupy a special position as quasi-judicial officers and representatives of the public.

For corporate defendants, prosecutors thus have some duty to look out for the interests of corporate constituents. That entails understanding governance profiles and having a defensible rationale for proposing governance terms. It is therefore logical to expect formal investigation into governance ex ante and publicly articulated rationales for terms ex post.

The paper then explores the benefits and costs of this proposal, as compared to both the status quo and the alternative regulatory conception. Immediate benefits are improved analysis ex ante—the lesson of Andersen that all large businesses are not the same—and tailor-ability of terms ex post—the lesson of AIG to proceed contextually.

With time, advantages compound by building a body of knowledge and precedents, providing a basis for informed external critique and offering the net virtues of transparency. 

As to objections, direct costs are real but modest. In the beginning, costs per case might average $100,000, most costs going to compensate for the lack of prosecutorial expertise in corporate governance. And that low cost is important to avoid discouraging prosecutors from using DPAs when they are the best way to resolve a case. Those costs would decline over time, moreover, as the knowledge base grows.

Skeptics may question the proposal’s potency, since it is up to prosecutors without formal external scrutiny. But prosecutorial restraint can be effective, as epitomized by the 30-year tenure of Harry Connick Sr. as D.A. in New Orleans, where the practice of having staff provide written rationales for decisions instilled a culture of fidelity to the rule of law. Further, unlike the status quo or regulatory alternative, the proposed approach gives prosecutors reputational and other incentives to make governance terms in DPAs effective.

The paper’s final part illustrates governance terms that have or could appear in DPAs and offers credible explanations of them—intended to show the proposal’s efficacy.

In short, the proposal recognizes the proliferation of DPAs as a novel form of corporate criminal justice that would benefit from being formalized, systematized and catalogued, rather than maintained in the black box of prosecutorial discretion. I urge the DOJ to take the lead by updating its guidelines on corporate criminal prosecutions accordingly.

In conclusion, about 300 DPAs are now in existence—the majority made in the past few years. Looking at that same group of DPAs, those who seek to oust prosecutors from the boardroom see frequent and extensive incursions into corporate governance that must be repelled while those who perceive excessive leniency are eager for greater prosecutorial inroads into governance.  Under my approach, the exact DPA population or density of governance terms becomes less important than whether there is investigation ahead of time and an articulated rationale afterwards 


* On the paper, called Deferred Prosecution  and Corporate Governance: An Integrated Approach to Investigation and Reform, thanks for helpful comments to Miriam Baer, Stephanie Cuba, Lisa Fairfax, Roger Fairfax, Brandon Garrett, Peter Henning, Renee Jones, Thomas Morgan, Michael Perino, Paul Radvany, Adam Spilka and William Wang. For the opportunity to present drafts of this Article as a work-in-progress, thanks to participants in workshops at Benjamin N. Cardozo School of Law, Fordham University School of Law, New York Law School and St. John’s University School of Law.