Mr. Thompson frequently speaks from notes and may depart from the speech as prepared. However, he stands behind the speech as presented in written format.
Good Morning. I am deeply honored to present a lecture named after former Senator Charles Goodell. Senator Goodell was a dedicated public servant who made a number of important contributions at both the state and national levels. His stewardship of the Vietnam War era Presidential Clemency Board helped heal the wounds of a divided nation. His son and I are former law partners. It is really good to be with you in these beautiful surroundings.
You are considering this week the role of ethics in business conduct. This topic is not only important, it is extremely relevant. We all read last week about the indictment of Ken Lay.
Consider where we were just two short years ago — July 2002. By July of 2002 we had experienced the bankruptcies of several large public companies, including Enron, World Com and Adelphia. Our financial markets were shaken, and there was seemingly nightly news of alleged criminal conduct at the highest levels in some American corporations.
As a government official at the time, it was a real time of crisis. I truly believed our capitalist system was in peril. I observed that many people had simply lost confidence in business. Consider the following Gallop poll taken in July 2002 that surveyed what occupations people trusted. At the top of the list were teachers. 84% of those surveyed said they would trust teachers, and people who run small businesses were at 75%. At the bottom of the list were CEOs of large corporations at 23%. The CEOs were just ahead of managers of HMOs at 20% and car dealers at 15%. Interesting, the CEOs scored worse in the poll than lawyers and government officials.
With this backdrop, I would like to discuss the federal government’s response to the spate of corporate scandals and note why I believe it was the right response, despite some criticism of the federal efforts as being too heavy handed, too extreme, too costly and even unnecessary. Next, I would like to discuss my observations as to why the scandals occurred and two developments that I believe will go a long way toward preventing the type of scandals we have experienced from reoccurring.
President Bush and Congress, both Democrats and Republicans, deserve a lot of credit for stepping up to the plate and authorizing and supporting a measured regulatory and an appropriate, but very strong, enforcement response to the scandals.
Let us look at the Sarbanes-Oxley legislation. I do not believe anyone can seriously say that this legislation is not positive. Its provisions promote transparency and greater accuracy in financial information. Other positive and needed provisions promote auditor and director independence.
There has been intense criticism of one of the provisions, Section 404, which directs public corporations to tighten internal controls. Many say that the costs of section 404 compliance are too high. Interestingly, when one really examines the actual costs of Sarbanes-Oxley compliance for many companies, you will find that the increased compliance costs are only a very small fraction of a company’s operating expenses. And some corporations, like General Electric, have actually said that there are positive benefits from section 404 work. In fact, GE actually views the costs, which include employee training, as an investment.
But the fact remains that there should be costs if Sarbanes-Oxley will have an impact. Audit costs may have been too low prior to Sarbanes-Oxley, causing audit firms to sacrifice their independence and seek more lucrative consulting work from their audit clients. There is no doubt that this reduced auditor independence was a contributing factor to the corporate scandals.
But the President also went beyond increased regulatory enforcement. He acknowledged that government cannot, and should not try, to remove all risk from investment. The President also noted that while government can do more to promote transparency and ensure that risks are honest, the government MUST ensure that those who breach the trust of their shareholders and employees are punished.
So President Bush established the Corporate Fraud Task Force to, in his words, “use the full weight of the law to expose and root out corruption.” The Corporate Fraud Task Force was designed to use criminal enforcement as a means to restore confidence in the country’s financial markets.
The Task Force, which was established in July in 2002, has been very successful. Very complex investigations and fact patterns that previously took as long as three to four years to complete were substantially completed in record breaking time. Federal prosecutors and agents from the FBI, Postal Inspection Service, and IRS recognized that they would need to respond quickly to the scandals. When I left government in September of 2003, the Task Force had obtained over 250 corporate fraud convictions or guilty pleas, including at least 25 former CEOs.
There have been critics of this approach. There are some who say the government’s tough regime of criminal enforcement has gone too far. It demonizes honest business people and discourages risk taking.
Well, the cases being investigated and prosecuted by the Corporate Fraud Task Force involve cooking the books, lying and obstruction of justice. The government cannot ignore this conduct even if this type of aberrant, criminal conduct exists within, I believe, only a tiny minority of American corporations. While the measured regulatory framework we have enacted that promotes transparency and more uniform and accurate information is good, there are limits to any regulatory regime. Overzealous and sometimes mindless regulation should be avoided at all costs. Too many regulations, rules that become byzantine in their complexity, or rules that seek to advance social policy preferences unrelated to the general economic welfare can, and often do, seriously stifle innovation.
History has shown that increased regulation can never cover all possible forms of abuse. That is why vigorous criminal enforcement is more harmonious with our capitalist system which is the envy of the world. The criminal laws set a standard whose transgression is clear. Criminal laws do not, by and large, creep toward inserting the government as the decision maker and undermine the entrepreneurial spirit. A strong regime of criminal enforcement leaves honest business people free to compete while weeding out those few — and I emphasize few — who break the law.
I am often asked, “Why are these corporate scandals happening?” I am not an economist or a sociologist so I really do not know why from an academic standpoint. But my experience as a prosecutor and white collar criminal defense lawyer tells me that we should look at corporate cultures. As those of you who work in large corporations know, companies develop their own methods that guide employees’ thoughts and actions. That culture is a web of attitudes and practices that tends to replicate and perpetuate itself beyond the tenure of any individual manager. That culture may instill respect for the law or breed contempt and malfeasance. The organization itself must be held accountable for the culture and the conduct it promotes.
Now some have argued that certain businesses are simply too big or economically important to be subjected to criminal sanctions, even for pervasive or serious criminal conduct by senior management. Some have said that corporations or business entities should not be indicted. Not only do I strongly disagree, this position is not supported by existing law which as a government official I could not ignore. It is a fundamental principle of American law that business organizations, including corporations, may be held responsible by the criminal law for the wrong doing of employees or agents. This was established by the U.S. Supreme Court as far back as 1909. Even at the turn of the century the Supreme Court recognized the economic power of corporations. It noted that the “great majority of business” transactions are conducted through corporations.
The turn of the century Supreme Court also recognized that civil sanctions do not have the power of criminal penalties to concentrate the corporate mind and change corporate culture. Some large business organizations, particularly public companies that are already regulated in myriad ways, sometimes have the disappointing tendency to view civil sanctions as merely the “cost of doing business” a cost that can be passed on to customers and shareholders.
At the turn of the century the Supreme Court recognized that without corporate criminal liability there would be no effective deterrent to a corporate culture that – expressly or tacitly – condoned criminal conduct. Instead, corporations could merely appoint a “vice president in charge of going to jail” who would serve as a scapegoat for wrongful acts that actually benefited the corporation.
Now at the beginning of the corporate scandals, federal prosecutors did not understand how to deal with corrupt corporate cultures. Corporations were rarely even considered for prosecution, despite the existence of serious and pervasive criminal conduct within the corporation’s ranks. I directed federal prosecutors to assess the possibility and prospect of charging the entity itself in every corporate fraud investigation under certain, limited circumstances. Corporations should not be treated leniently because their artificial nature or economic importance, nor should they be subject to harsher treatment.
The Justice Department always takes into account the real world results of prosecutorial decisions. Prosecutors consider a number of factors before deciding whether to seek an indictment against a corporation. These include the pervasiveness of the wrongdoing in the corporation, the nature and seriousness of the offense, the corporation’s history of similar conduct and what lawyers call the collateral consequences of prosecution; that is, the harm to shareholders and employees. All of these factors are considered. But one important legal fact remains. At the turn of the century, the Supreme Court held that a corporation is a person in the eyes of the law for purposes of criminal liability. Once you accept this fact — which is the law — then it is clear that no person, even a corporation, is above the law.
Sarbanes-Oxley has brought about much needed improvements in transparency and accountability in the books and records of public companies. Tough criminal enforcement will send a much needed message of deterrence for anyone contemplating self-dealing and financial fraud. But this will not be enough as we all know. For we all know that crooks will always be amongst us.
There are, however, two developments in the area of corporate governance that I believe are significant and may go a long way toward preventing the type of scandals we have just experienced from reoccurring. At the very least, these developments will minimize the likelihood of these scandals happening again.
Section 406 of the Sarbanes-Oxley Act and the implementing rules by the SEC call for a code of ethics for the CEOs and chief financial officers of public companies. This concept has been embraced and greatly expanded upon by the revised guidelines for organizations recently published by the influential U. S. Sentencing Commission. Although the guidelines technically apply only when an organization is being sentenced for violating a criminal law, the guidelines have, over the years, greatly influenced the design, implementation and administration of corporate compliance programs. The guidelines are scheduled to go into effect on November 1, 2004.
The main theme of the revised guidelines is a greater emphasis on ethics as opposed to mere compliance with the law. The guidelines encourage companies to promote “an organizational culture that encourages ethical conduct and a commitment to compliance with the law.” The revised guidelines give specific directions to companies as to how an effective ethical environment can be accomplished.
High level corporate officials and boards of directors will be required to take an active leadership role in the operation of ethics and compliance programs. Senior management and the board of directors will now be expected to understand the major risks of unlawful conduct facing their companies and how their companies’ ethics and compliance programs are to work to counteract those risks. The Board of Directors and Senior Management can no longer simply delegate the ethics and compliance function to officials lower in the organization. They must understand what is going on and what problems and vulnerabilities their companies may have from a compliance standpoint.
Companies will now also be required to evaluate the overall effectiveness of their compliance programs by undertaking periodic risk assessments to determine the scope and nature of risks of violations of law associated with a company’s business. These requirements make certain that ethics and compliance programs will be real; they can no longer exist on paper only. What they will require companies to do is actively and seriously investigate allegations of wrong doing. They will require education and training programs of substance and, most importantly, the corporations’ problems and vulnerabilities will go directly to the board of directors. When this happens, the board cannot afford to bury its head in the sand. Under legal standard and case law in existence before the revised guidelines, the board could escape liability for corporate wrongdoing by showing simply that it had attempted in good faith to ensure that an adequate corporate information gathering and reporting system was in place. Now, board members will be required to get “their hands dirty” and become knowledgeable about a company’s compliance problems and vulnerabilities.
But the most important development in terms of preventing the reoccurrence of the corporate fraud we have experienced comes from a little known provision of the Sarbanes-Oxley Act. Section 806 of the Act establishes a new federal cause of action to protect whistleblowers who are employees of public companies who provide information to the authorities that they believe constitutes a violation of federal securities laws or involves other types of corporate criminal conduct. The provision is designed to shield these whistleblower employees from retaliation by the corporate employer.
An employee claiming retaliation because he or she uncovered corporate fraud can file a complaint with the Department of Labor which will investigate the claim unless the employer can show that it would have taken adverse employment action despite the employee’s allegations of corporate fraud. From a purely practical standpoint, this will be a very difficult proposition for an employer. In today’s environment there will be a presumption, albeit informal or subjective, in favor of at least investigating the claim.
Employees who prevail in whistleblower cases are entitled to relief which may include reinstatement, back pay, interest, litigation costs, and relief that will make any good plaintiff’s attorney interested in the case, compensatory damages. The provision does not provide for punitive damages, but the statue does not preempt existing state of federal law. So an employee aggrieved under the whistleblower provision can file multiple claims and let the Department of Labor, with its resources and authority, investigate claims and use the results as a hammer in other cases.
Whistleblower provisions have been very effective in defense procurement and healthcare fraud cases. The possibility of whistleblower suits has, I believe, encouraged effective compliance efforts in these industries. I believe the Sarbanes-Oxley whistle blower provisions can have a positive impact on the prevention of corporate fraud.
Companies will soon learn that the best protection and defense against a potentially serious and morale lessening whistleblower suit is to have in place a corporate culture that emphasizes ethical conduct by all involved in the company. Such a positive corporate culture, consistent with the revised sentencing guidelines for organizations, will emphasize openness and employee reporting of compliance problems. This type of approach will give senior management and the board of directors early warning of actual or potential criminal conduct.
All of this is not pie in the sky; it makes sense. Avoiding the problems associated with whistleblower protections contained in Section 806 is not only the ethical and moral thing for corporations to do in order to protect shareholder interests, it is also simply good business. This provision, probably more than any other, will foster good corporate conduct because it turns every employee of the company into a potential whistleblower who will be afforded the protection of the federal government.
Yes, the crooks will always be with us but from a prevention standpoint, we need to do everything we can to discourage corporate criminal conduct. I think we are on the right track.