Copyright © 1995 The Bureau of National Affairs, Inc.

4. Compliance Program Costs and Risks

For some in government and academia, there is no question that companies should seize this new opportunity and adopt comprehensive compliance programs that meet the standards of the Sentencing Guidelines. To them it appears to be an easy proposition: here is a chance to reduce sentences in the event of criminal proceedings, and all a company has to do is follow the steps in the guidelines. Why would any manager miss out on such an opportunity?

In fact, however, this is not an easy question to answer. There are serious pros and cons to implementing a full guidelines-type program. Those outside the corporate realm who fail to recognize this forget the basics of economics--only limited resources are available to any organization, and a compliance program places significant demands on those resources. Moreover, because of the intrusive nature of the U.S. legal system, a compliance program carries its own set of risks that can mean even greater costs to a company. But despite these costs and risks, companies do adopt programs and will continue to do so because there are even greater real-world benefits from these programs.

a. Administrative and other costs

Why might a company not implement a program, or only do so on a paper basis? One issue is the administrative expense of the program itself, an immediate cost in a corporate world that has seen a wave of downsizing and shrinking of staff functions. Any program is likely to require substantial input from lawyers, whose time is particularly expensive. Whether the job involves writing compliance manuals, giving seminars to thousands of employees, or conducting audits of company files, this is time that carries a premium price tag. Add to this the cost of managers who should play a role in the program--the auditors, trainers, environmental experts, compliance officers--and there is a potential for development of a significant bureaucracy.

The magnitude of this expense can be illustrated by starting with just one element of a program. A typical company might have a laundry list of subject areas to deal with--antitrust, environmental, workplace safety, government contracting, securities fraud. The training for just one, such as antitrust, covering a sales force of 2,000 employees at two hours per session, and dividing the universe into groups of 20 employees, would take five weeks of a lawyer's time just to cover the giving of presentations. On top of this is preparation and travel time. Additionally, there is the all-important time spent with attendees after the sessions surfacing questions and concerns. This one aspect of one subprogram could take two months of highly paid legal staff time. If a compliance audit program is included, along with hot line questions and investigations, production of written compliance materials, and other elements of the program, the result is a cost figure that still only represents a fraction of the whole. The same calculation can be repeated for each of the other legal subject areas.

The administrative cost is only the most obvious and easily calculated of the expenses. For each hour of a lawyer's time spent in training, there is a multiple of 20 representing the management time devoted to participating in the seminar. In the hypothetical example above, with thousands of employee hours devoted to training in a number of compliance areas, there is a cost measured in person-years just for training. Added to this is time spent responding to compliance audits, reading compliance educational materials, and assisting in investigations.

Critics of business may dismiss concerns about these costs as just an example of perverse over- attention to the bottom line. What they miss, however, is that such programs not only have a serious cost, but they also impose an opportunity cost on society. Every hour and every dollar devoted to compliance programs is diverted from production, sales, or other necessary activities of the company. And every cost must be reflected in the company's products and its ability to pay its employees. In economic terms, it is not that no one in industry cares about compliance; it is just that every allocation of resources to one function comes at the expense of something else.

b. Compliance program risks

Program expense is not the only deterrent to a strong compliance program. The risks of an intrusive but effective program can be quite daunting. Information gained through a compliance program may necessitate drastic changes in operations. Environmental or safety fixes can cause entire plants to be idled. Other discoveries can require major expenditures to remedy violations that might otherwise have remained undiscovered. One company's honesty might prompt it to handicap itself while a more unscrupulous operator seizes a competitive advantage.

If the compliance program uncovers a criminal violation, the company must then decide whether to follow the direction of the Sentencing Guidelines and turn itself in.¹⁰ In some circumstances reporting may be obligatory--for example, when certain environmental transgressions have occurred or when a company that is publicly issuing securities discovers material securities law violations.

The company that finds a criminal violation and turns itself in then faces the full range of prosecutorial treatment--even though the government might never have discovered the violation without the company's help. The firm may face enormous fines, terrible publicity (with potential effect both on consumer perception and stock price^10a), six- and seven-digit litigation expenses, and potential suspension or debarment from government business.

The company that operates a hot line and compliance audit program may also be confronted with a hostile litigation environment in which those laudatory efforts are viewed as mere tools for adversaries to exploit. A company may try to set high standards for employees by promulgating a tough code of conduct, only to have the standards thrown in its face--by tort plaintiffs or shareholders--when the employees fall short of those goals. Compliance audits that identify what may be a violation will be sought in discovery for their potential use as admissions against interest and as road maps for further discovery.¹¹ Contingent-fee tort lawyers and shareholder claimants will zero in on the self-critical products of a tough compliance program.¹²

An "effective" program under the guidelines will also face opposition from some managers because of the potential impact on the company beyond the financial and risk elements. The emphasis on audits, hot lines, discipline, and the like can appear to employees to give rise to a police-state working environment. The guidelines reflect a prosecutor's view of the world--a view that can conflict with current efforts to empower employees and delegate authority downward. It can also conflict with the cooperative team approach inherent in many company quality programs. The guidelines appear to require an internal criminal justice system approach that can risk defaming employees, seeming to invade their privacy, and triggering other labor relations problems.¹³ It may even be that the guidelines' emphasis on the negative will work against their effectiveness.

5. Compliance Program Benefits

The costs and risks are undeniable, and yet companies continue to expand old programs and implement new ones. Why is that clearly a better choice than to ignore the guidelines and simply trust in the good will of the company's employees? What are the advantages to a company and its managers of developing compliance programs that meet the guidelines and are also effective in deterring misconduct?

a. Prevention of misconduct

Fundamentally, whatever the risks of having a compliance program are, the risks of committing violations of the criminal laws outweigh them. Throughout the legal system, the businessperson sees the expansion of criminal liability for business conduct. The list of actions that can result in criminal liability for a company and its employees, ranging from environmental offenses to failure to report large cash transactions, continues to grow.¹⁴ Companies can face such liability based on the actions of the newest or most junior employee. ¹⁵ In the blunt words of G.E. Aerospace's general counsel, "any company that thinks it has no realistic chance of criminal indictment is living in a fantasy world."¹⁶

Not only has the risk of a violation increased, but the consequences of such violations have grown apace. Each legislative session tries to outdo its predecessor in increasing fines and other penalties. Under the Sentencing Guidelines, the judge's discretion to temper the impact of the statutory penalties has been supplanted by a formula intended to ensure backbreaking penalties for violators who do not meet the standards for mitigation credits. Penalties for companies can include being cut off from the privilege of handling government contracts; for some, this could be a knock-out blow. Moreover, regardless of the outcome of a criminal investigation, the cost of defense counsel represents an enormous penalty in itself.

A strong compliance program serves to detect and provide early warnings before misconduct develops into a criminal violation. Preventing even one criminal violation would likely cover the costs of the compliance program. It is also advisable to remember that each company employee is also a member of the community, whose own family and financial well-being are affected by business misconduct. Those in business are potentially their own victims and thus have an interest in preventing pollution, political corruption, price fixing, and other offenses against the public.

b. Effect on prosecution decisions

It is naive, however, to expect that any compliance program will prevent all violations. As a purely statistical matter, a company with 50,000 or 100,000 employees is going to experience lawbreaking somewhere in the organization. If the company has done its best to meet the guidelines' standards and has exercised due diligence to prevent violations, it should be able to make a convincing argument to prosecutors that it should be spared prosecution. What benefit does society derive from punishing an organization that has already met society's standards for an effective compliance program? Indeed, prosecuting such a company would have exactly the wrong effect--it would prove that it is better to fight the system than to try to cooperate.

There are officeholders who are prepared to recognize this important policy. Both the Department of Justice in the environmental enforcement area and the U.S. attorney for the district of New Jersey have been outspoken on this point.¹⁷ Other prosecutors on the federal^17a and state^17b levels have expressed similar views. An effective compliance program can thus help to convince prosecutors that there are other candidates in the business world who are more appropriate targets for prosecutorial guns.

c. The criminal liability issue

If the worst does happen and a prosecution occurs, the existence of a compliance program may aid the company that chooses to go to trial in contesting liability (though a decision to contest liability would likely cost the firm mitigation credits at sentencing if it is later found guilty¹⁸). On the issue of liability the law has a great distance to move before it recognizes the connection between corporate responsibility and the role of strong compliance programs. Although some courts have recognized the role of compliance programs in determining corporate guilt,¹⁹ it is still easy for courts to dismiss compliance programs with a wave of a hand, as if they were beneath the level of judicial recognition.²⁰ Thus the Second Circuit Court of Appeals, in United States v. Twentieth Century Fox Film Corp.,²¹ simply concluded that a criminal contempt defendant's efforts to assure that its employees followed a consent decree were not relevant to liability. This conclusion rested on the court's assertion that the court had to protect its authority through criminal proceedings. On the other hand, such a program would have been relevant in a civil proceeding. Other courts may be tempted to follow this precedent because it avoids the whole issue of compliance--something with which most courts have no familiarity. But in time, as courts become familiar with compliance programs through sentencing proceedings under the guidelines, it should be expected that they will be more receptive to such programs and accord them a role in determining corporate culpability.

d. Penalty mitigation

Under the guidelines, a company that adopts an effective program, turns itself in upon discovering a violation and cooperates with the prosecution, and has no involvement of high-level officials in the offense may earn up to a 95 percent reduction in the penalty.²² (The one area in which this does not hold true involves antitrust violations, where the Department of Justice holds fast to the notion that the ability to prosecute and impose penalties no matter what a company does to prevent violations is all that matters. For these offenses the mitigation credit is substantially weaker.) Certainly no company would want to have to face its shareholders and explain why it paid a $100,000,000 fine when its competitors either escaped prosecution or paid only a fraction of that amount.

There are those in business who are reluctant to pay the full price for this mitigation factor and would not voluntarily report a violation. There is also a high risk that a company would not fulfill all of the requirements to qualify and thus would not get the mitigation credit. For example, a small department with one manager supervising 200 employees might commit a violation involving that manager and thus cause the company to forfeit the mitigation credit.

The guidelines, however, provide significant benefits even in such cases. First, a court will take into consideration a company's compliance efforts in determining where, within the minimum and maximum range under the guidelines, the company's fine will fall.²³

e. Avoidance of probation

Even more important than this is the ability to avoid the threat of probation.²⁴ A company with no compliance program will invite the court to impose one as a condition of probation. That will mean appointing a probation officer to poke around the business, and requiring management to follow that official's ideas on how to manage the company so as to prevent future violations. Managers trying to decide whether to buy into the guidelines or to take their chances under probation should let their imaginations play with the picture of a government official attending board and management meetings, directing compliance audits, and establishing a disciplinary system within the company.

f. Effect on civil liability

The value of a compliance program in the criminal justice system under the guidelines is fairly obvious. Less obvious, but potentially very important, is the role such programs could play in civil litigation. Of course, an effective program helps forestall the kind of missteps that lead to private litigation (or, for that matter, equally onerous regulatory enforcement actions). But in the event of litigation, a company faced with tort claims, for example--environmental harms, safety violations, fraud, etc.--will want to convince a judge or jury that it is a responsible corporate citizen that should not feel the lash of punitive damages. On the other side of the courtroom, plaintiff's counsel may incite the jury to punish the company that made no efforts to prevent the misconduct that hurt his or her client. An effective compliance program should have a role to play in this determination.

g. Reputation

A well-designed and carefully implemented compliance program can have benefits even outside the legal system. A program must be part of the company's culture to be most effective. If the program helps reinforce the employees' sense that the company is fair and honest, this can redound to the company's benefit. Having a reputation as another Johnson & Johnson can enhance employee morale and aid in recruiting the brightest and best employees.

h. Protecting the company as target of misconduct

Creating a company culture that inspires proper conduct, and having a compliance program that is interactive²⁵ and detects misconduct at an early stage, will also prevent the type of crime in which the company is the target. Employee theft of company resources, acceptance of bribes to influence company decisions, and safety violations that lead to lost workdays all have direct bottom-line consequences. Each of these types of misbehavior will be exposed in a well-designed and well-executed program.

i. Business relationships

Having a program that meets the guidelines standard may also become the price of admission for those who want to partner with blue chip companies. Under the guidelines, companies must extend their programs to include "agents," a term defined to include independent contractors.²⁶ In selecting another firm to act as sales agent, advertising agency, or joint venture partner, companies that are trying to meet the guidelines standard will need to be particularly careful. This rather clever, but frequently overlooked, aspect of the guidelines will likely extend the guidelines' reach to anyone seeking to do business with major companies.

j. Conclusion

On balance, while the guidelines set a rigorous standard, and notwithstanding their negative focus, companies weighing the options will see that there is likely to be only one course they can choose. Continuing to develop compliance programs, but now enhancing those efforts to satisfy the guidelines, is the immediate choice that most companies will have to make.

The choice, and the implementation of that choice, will not be easy. Publications such as this one, and such journals as the Corporate Conduct Quarterly, will ease the burden of finding out what to do and how to minimize the risks. Ultimately, if company managers understand what is happening and press government for change, and if those in government realize that the enormous potential of effective compliance programs cannot be realized until government takes a much more supportive role than that initiated by the organizational guidelines, the decision will become much more straightforward.²⁷ If that day comes, those who champion compliance work and seek to prevent companies and their managers from running afoul of the rules may do so with a singleness of purpose and without being subject to ambush by the legal system.

Wednesday, 03-Sep-97 11:51:31