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January/February 1991 - By Andrew W. Singer

Ethics Programs Could Save Companies Millions Under New Sentencing Guidelines

The new U.S. corporate criminal sentencing guidelines provide a compelling reason why companies should invest in ethics/compliance programs.

These guidelines, which are designed to eliminate sentencing disparities from one federal court to another, propose “drastic” new penalties for corporate crimes—as high as $495 million, according to Jeffrey M. Kaplan, a partner in the New York law firm of Chadbourne & Parke and a specialist in white collar crime. That’s the bad news.

The good news is that companies that make credible efforts to deter crime, through the development and implementation of comprehensive compliance programs, can have those penalties significantly “mitigated”—down to zero in theory—according to Kaplan.

This represents a dramatic turn in corporate criminal sentencing philosophy. For the first time, he says, the government is proposing “the carrot as well as the stick” to deter corporate malefactors.

The message now is: “You have to do things before there is a problem. Given the magnitude of the fines it could be the difference between bankruptcy and salvation for a company that gets into trouble.”

The guidelines, developed by the U.S. Sentencing Commission, are expected to become law this year.

‘Heads they win, tails I lose’

Until now, the system has been riven with anomaly regarding corporate compliance programs. A company can invest heavily in such programs, but that may account for little at sentencing time.

In one case in the early 1980s, United States v. Rockwell International Corporation (see Ethikos, July/August 1990), the corporation itself revealed that employees working on a satellite program had been double-billing the government. Rockwell had sought to prevent such incidents, the company said.

It had distributed a code of ethics to all employees, implemented an ethics training program, set up an ombudsman’s office and an ethics hotline, and undertaken an outside-auditor review of its compliance systems. Despite its efforts, Rockwell had levied against it in 1989 a fine of $5.5 million.

Around the time of its sentencing, the company asked: “If a defense contractor spends as much, time, effort and money on self-governance, as Rockwell has, deals with an incident of employee wrongdoing in full accordance with the government’s expectations as Rockwell has, and is then rewarded with the wrath the government normally reserves for the recalcitrant, is such effort warranted?”

(For its part, the government charged that Rockwell’s program wasn’t quite the “model” compliance program that the company claimed.)

Experts say the case illustrates the “heads they win, tails I lose” situation that has prevailed until now. Even in previous Commission drafts over the last year and a half—this is the fourth draft—mitigation for “good faith” efforts did not amount to more than 20 percent of the penalties, according to Kaplan.

Two key conditions

To get full “mitigation” of fines—the “good faith” discount, as it were—an organization must meet two key conditions under the proposals.

First, it must turn itself in when it commits a violation. (Or, according to the draft, management must have “voluntarily and promptly reported the offense to appropriate government authorities prior to public disclosure, the commencement of a government investigation, and the imminent threat of disclosure of the wrongdoing.”)

Second, the company must have previously implemented an “effective program to prevent and detect violations of the law.”

What constitutes an effective compliance program?

In the current draft, the Commission spells out the elements of a comprehensive compliance program—this in recognition of the reality that many companies still regard compliance as little more than handing out policy booklets to employees.

The Commission has laid out “seven general types of steps to assure compliance with the law” (see box on page three). Elements four and five are particularly significant, according to Kaplan.

The fourth requires that “the organization must have effectively communicated its standards and procedures to agents and employees, e.g., by requiring participation in training programs and by the dissemination of publications.”

This is the “most important single area,” asserts Kaplan, since it is here that a company “can really prove that it is exercising good faith” in ensuring compliance. Companies can conduct ethics awareness seminars, disseminate videotapes, bring in ex-white-collar offenders to speak to groups. “This is one area where management should now be reviewing its programs,” says Kaplan.

Appointing an ombudsman

The fifth element in the draft is also critical. This says that “the organization must have taken reasonable steps to achieve compliance with its standards, e.g., by utilizing monitoring and auditing systems reasonably designed to ferret out criminal conduct by its agents and employees and by having in place and publicizing a reporting system whereby agents and employees can report criminal conduct within the organization without fear of retribution.”

In effect, this urges corporations to “have an independent ombudsman,” says Kaplan, as well as establishing auditing procedures. “If they don’t have it, they won’t have the protection of “extraordinary mitigation” of criminal fines that is available under the guidelines.

“In showing good faith, a company should not be limited to what’s in [the Commission’s draft],” adds Kaplan. A company can and should take additional measures. It might tie compliance into managers’ performance evaluations. It can institute regular reports to the board of directors on compliance measures.

Although the Commission’s draft refers to audits that measure “lawfulness,” “you can go further and test employees’ knowledge of compliance-related materials,” says Kaplan. It might even be something along the line of spot quizzes. The idea is that a company continues to evaluate compliance as it would a product that it manufactures. “Few companies do this now.”

A proliferation of ethics programs

Kaplan expects to see a proliferation of “ethics” programs. “There will be a tremendous increase in the next year or two of ombudsmen, legal auditors—of ways to make corporate policy books [i.e., corporate codes of conduct] come alive.”

Defense contractors have had to have such programs in past years. “Now all companies, regardless of industry, have to do them,” he says. It is a significant development “because it cuts across the board,” affecting all industries. “It sets a standard and extreme penalties for failing to meet that standard.”

“Every company should look at it,” says another corporate attorney who has been following developments closely. “Do we meet the standards? Any lawyer who represents a business client has to look at these and raise questions.”

Most large companies will face a criminal conviction of some sort over the next 10 years—even “good companies,” Kaplan observes. It’s a matter of statistics. The largest corporations have more than 100,000 employees—and any mid-level employee can bind the company to a criminal action.

Top-level management involvement in a criminal action isn’t necessary to reach “offense level 40,” carrying its $165 million fine. This can be tripled depending on other factors, such as the loss caused by the criminal conduct. “The act of a mid-level manager could get a company indicted,” Kaplan notes.

“The overwhelming majority of large companies will face it, and now the penalties are drastic.” The penalty for the average corporate crime from 1984-87 was $54,000. “The fines we’re talking about here are wildly in excess of that.”

(One example, cited in a December 11, 1990 story in the Wall Street Journal: Ashland Oil Co. was fined $2.5 million for spilling 500,000 gallons of oil in the Monongahela River in 1988. Under the new draft guidelines, it could have been fined $30 million to $50 million.)

Not all corporate representatives are willing to give the new proposals their unhesitating support.

 “Any time the government sets standards, it freezes the development,” says Joseph Murphy, senior attorney with a large telecommunications corporation. Once the government has outlined seven steps, companies may well ask: Why do something more?

Murphy also finds troublesome the draft requirement that when a company learns of a violation, it must turn itself in. “The government is fond of that sort of thing. I’m more skeptical. In many cases it should be enough that if the company finds the violation, it ends it. But turn itself in? That’s another issue.”

Overall, though, “I think it is very positive,” says Murphy, a member of the advisory board of the Business Ethics Study Team (BEST), a New York-based group. The Commission “recognizes the significance of voluntary compliance programs—and as something more than a program to be stamped out with a cookie cutter.”

Expected to become law this year

The Commission’s recommendations are “likely to become law in 1991,” says Kaplan. Even if they’re not, they are “virtually certain” to be instituted in some similar form. There simply isn’t a constituency for opposing such a “sensible” proposal, in Kaplan’s view.

Paul Martin, a spokesperson for the U.S. Sentencing Commission, agrees that some sort of “mitigator” for corporate compliance programs will be in the final Commission draft. The point to emphasize: “Just to say that you have a compliance program isn’t enough.” Whether the final draft will cite seven crucial “steps” to certify compliance, or six or eight steps, remains to be seen, observes Martin, but something fairly detailed will be in the eventual bill.

The Commission’s final draft will be submitted to Congress by May 1. It is expected to be ratified. If Congress takes no action at all, the guidelines automatically become law on November 1, 1991.

In sum, this is “perhaps the most important development in corporate compliance in years,” according to Kaplan. “Any company that is not examining these questions now is making a big mistake.”

Andrew W. Singer is publisher and co-editor of ethikos.
Reprinted from the January/February 1991 issue of ethikos
© 2005 Ethikos, Inc. All rights reserved.

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