Multiple recent developments suggest that governing boards will continue to be called upon to address the personal liability concerns of corporate gatekeepers and other executives. There may be no clear indication yet of whether the Trump administration will endorse government individual accountability initiatives, such as the Yates Memorandum. But these new developments indicate that the “pipeline effect” of investigations commenced after the Yates memo was issued in September 2015 will be felt for the foreseeable future.
Such an effect will undoubtedly fuel the self-interest tendencies of many key corporate leaders. That, in turn, could enhance the potential for conflict between the board and individual executives across a broad spectrum of organizational initiatives; e.g., the pursuit of strategic projects, compliance with organization policies, and cooperation with internal investigations. The board will be expected to mollify these concerns, as it has since the Yates memo was issued. Yet if not planned for, that task could easily become an unwanted distraction from more pressing board responsibilities.
Who Is a Gatekeeper?
The term “gatekeeper” refers to those who have direct, formal governance authority, and others who perform key roles in promoting corporate responsibility. Its origin is in the public policy and governance best practices of the Sarbanes-Oxley era in 2002. Regulators often use the term to refer to those within the organizational hierarchy who have fiduciary or professional obligations to spot and prevent potential misconduct and to respond to any problems that do occur. These individuals typically include auditors and lawyers, independent directors and committee members, and representatives of the private sector who similarly contribute to the oversight of corporate conduct; e.g., public accounting firms and outside legal counsel.
In recent years, the definition has expanded to include positions such as internal auditor and compliance officer, as those roles have evolved and assumed more organizational prominence. The most senior executives have not traditionally been considered gatekeepers. Yet, some regulators may nevertheless treat them as such due to their perceived fiduciary duty to maintain an organizational culture of compliance with law (the “tone at the top” concept).
While the Yates memo made the indelible connection to criminal liability exposure, concerns with “gatekeeper anxiety” can be traced to Securities and Exchange Commission Chair Mary Jo White’s cornerstone commitment in 2014 to focus the Commission’s enforcement commitment in part on the accountability of gatekeepers.
The Sources of Anxiety
The most obvious sources of anxiety are the enforcement policies of the Department of Justice, and to a lesser extent the SEC and other federal agencies that seek to reduce corporate misconduct by holding accountable all individuals who engage in wrongdoing. These policies have in many situations shifted the primary attention in government investigations from the company to allegedly culpable individuals (read: gatekeepers and executives).
The Consequences of Anxiety
An unintended consequence of these policies is the increased potential for conflict between the interests of the corporation and the interests of gatekeepers. In the context of a government investigation, the board’s primary fiduciary obligation will be to protect the interests of the corporation, and that may well mean giving up individuals believed responsible for corporate wrongdoing in order to secure leniency for the corporation in an ultimate settlement with the government.
Gatekeepers are increasingly aware of this obligation, and it may prompt them to become gun-shy; i.e., to engage in self-protective conduct that frustrates valid board strategic (and other appropriate) initiatives. This anxiety can become acute when the conduct of directors, and especially those on board committees, is called into question, presenting a unique form of potential conflict where perceived director self-interest is a distraction from the performance of fiduciary duties.
The Future of the Yates Memo
The result of this situation is great interest in the anticipated approach of the new administration toward individual accountability for corporate wrongdoing. While there has been no formal policy statement to date, the die may already be cast for the foreseeable future.
The likelihood of a Yates carryover effect was first referenced by Deputy Attorney General Sally Yates in her November 30, 2016 speech. In her comments, she noted that a significant number of corporate investigations that began after issuance of the Yates memo won’t result in public filings until well into the new administration. In those investigations, prosecutors have been evaluating whether any individuals should be subject to criminal or civil penalties. As Yates said, “I expect that, in coming months and years, when companies enter into high-dollar resolutions with the Justice Department, you’ll see a higher percentage of those cases accompanied by criminal or civil actions against the responsible individuals. It won’t be every case, but the investments we’re making now are likely to yield a real increase in the years ahead.”
As Yates predicted, a flurry of notable DOJ enforcement activity with individual accountability components became public in the early weeks of 2017. This included:
- The indictment of six former executives of a large international manufacturer on criminal conspiracy charges associated with allegations of efforts to withhold from regulators certain regulatory noncompliance information. The manufacturer itself pled guilty to obstruction, importation of goods by false statements, and conspiracy to defraud the United States, commit wire fraud, and violate the Clean Air Act. One of the indicted company officials was a senior corporate compliance officer – among the first examples outside of the finance industry of a corporate compliance officer being subjected to criminal charges. In addition, court documents implicated a member of the company’s in-house legal department in possible obstruction of justice issues, but to date no charges have been filed. (In an interview associated with the announcement of these charges, Yates used these developments to publicly assert the effectiveness of DOJ’s focus on individuals. “This isn’t just a paper policy — I think you’re seeing the results,” she Yates said. “There’s a shift in focus here that is across the board in the department, and it’s starting to bear fruit.”)
- The indictment of three former senior executives of an auto supplier on charges that they allegedly conspired to provide automakers with misleading test reports on rupture-prone airbags. The indictments were unsealed as the auto supplier separately pleaded guilty to criminal wire fraud and paid a $1 billion fine to resolve a DOJ investigation.
- The guilty pleas of two former pharmaceutical executives to price fixing and bid rigging charges associated with the alleged manipulation of prices of a particular medication. According to media reports, the charges are “the first…in an ongoing investigation of price fixing in the generic drug industry.”
Recent enforcement actions targeting individuals have not been limited to the automotive and pharmaceutical industries. In healthcare, for example, Yates-based principles of individual accountability are clearly seen in some of the latest Stark Law and False Claims Act-based complaints and settlements involving the Department of Justice and the Office of Inspector General. The particular elements of accountability applied involve (in certain instances) financial penalties, Medicare program exclusion, or waiver of indemnification rights. They affected senior corporate officers, including a former CEO, and a board chair.
The SEC can also be expected to continue its own enforcement emphasis on individual accountability, as has essentially been the case for years, regardless of the political party that holds the majority on the Commission. SEC enforcement staff is familiar with the bi-partisan refrain from commissioners that “corporations don’t act, individuals do.” While the future leadership of the SEC and the division of enforcement will be set shortly, and enforcement priorities may be recalibrated, it is unlikely that the SEC will radically depart from its emphasis on holding individuals accountable for their wrongful acts.
This may particularly be the case with respect to accounting cases–regardless of the future of the Dodd-Frank law. Indeed, any future legislative changes are unlikely to affect the SEC staff’s renewed focus on accounting and financial restatement cases. While the SEC has traditionally (and appropriately) been cautious in bringing enforcement actions against board members, audit committees must remain appropriately engaged in their oversight roles with management and external auditors, particularly in connection with a company’s “internal controls systems and processes.”
The Board’s Response
If the government’s focus on individual accountability isn’t going away soon, the impact on gatekeeper morale and organizational culture will remain a major board concern.
Boards will be continually called upon to deftly balance the need to preserve and enhance the loyalty and confidence of key corporate gatekeepers; the obligation to promote an organizational culture that encourages ethical conduct and a commitment to compliance with the law; and the ability to take steps to achieve credit for corporate cooperation should the organization become subject to government investigation.
While the most effective action plan depends upon the unique circumstances of an individual company, a successful board response might include elements of the following:
- An internal board-to-gatekeepers acknowledgement that Yates-based tension is likely to continue for the foreseeable future;
- Assuring gatekeepers that corporate strategic plans are consistent with the board- approved risk profile for the corporation, and that all major corporate strategy decisions have been carefully vetted by experienced legal counsel;
- Providing gatekeepers with clear legal advice on the proper implementation of approved corporate strategies and making it known that company lawyers are available to counsel gatekeepers at all times;
- Enhancing gatekeeper confidence in the effectiveness and rigor of existing corporate compliance programs and whistleblower and reporting up mechanisms;
- Assuring that in-house counsel serves as dedicated staff to the audit committee;
- Making a special effort to address the heightened concerns of members of the compliance and in-house legal departments following the recent indictments and authorizing access to outside white-collar crime counsel to help address areas of particular sensitivity (e.g., reducing the risk of obstruction of justice allegations);
- Considering special conflict-of-interest protocols to address situations where individual board and committee member conduct is under scrutiny; and
- With the help of qualified advisors, carefully reviewing the adequacy of existing indemnity and insurance coverage available to gatekeepers. The goal is to assure gatekeepers that state of the art coverage is in place with the best possible terms.
In an environment in which fluidity and uncertainty seem to dominate the board agenda, corporate leadership will continue to be called upon to devote significant time and attention to addressing the legitimate individual accountability concerns of corporate gatekeepers. The general counsel can play an important role in supporting the board’s ability to monitor regulatory developments and their impact on gatekeeper anxiety.
This post comes to us from Michael W. Peregrine, a partner at McDermott Will & Emery. Mr. Peregrine wishes to thank his partners Joshua T. Buchman and Rebecca C. Martin for helping prepare the post. The views expressed herein do not necessarily reflect those of the firm or its clients.