How to Improve Corporate Compliance with the Law

Corporations have been making news recently with repeated violations of the law. In some cases, such as financial services, the violations have occurred across large segments of an industry. Enforcement officials have imposed billions of dollars in sanctions against all the major U.S. financial institutions and many foreign ones as well. The large sanctions are the result of findings of recurring violations of law as well as recidivism.[1] Why have regulatory standards and enforcement policies led to repeated violations? Will the recent billion dollar sanctions deter future wrongdoing?  In my recent article, Corporate Wrongdoing: Interactions of Legal Mandates and Corporate Culture, I explore these issues by examining the philosophy motivating regulatory policy and action on the part of financial regulators in the U.S. and U.K.

Regulatory philosophy in the U.S. and U.K. long reflected an assumption of corporate commitment to law-abiding behavior. Mainstream corporations were viewed as embracing an ethical obligation to comply with legal mandates.[2] The result was a light-touch approach to enforcement policy—a policy relying on agreements to cease violations and not emphasizing the imposition of civil penalties. When law-abiding behavior was absent and a breach of legal standards was substantial, recurrent, or systemic, then financial penalties were imposed. More recently, regulatory philosophy has been modified to embrace the view that corporate actors are rational decision makers, choosing to comply, evade, or violate legal obligations based on cost-benefit evaluations. This regulatory philosophy reflects a neoclassical economic view, which assumes that corporate actors will comply with legal requirements if all potential costs of noncompliance exceed their benefits. In this scenario it is assumed that corporate actors assess risk based on a full appreciation of all the short-term and long-term consequences of their actions. The related assumption is that corporate decisions are linear, so that increasing the size of fines, for example, will have a direct and proportional impact on future decisions concerning legal compliance. This is both a reductionist and a linear view of human decision-making. The 2008 financial crisis has revealed flaws in both of these viewpoints.

Corporate decisions are determined by multiple interacting influences. Government as an institution, reflected in legal standards and enforcement policy and actions, is one influence.[3] Accepted corporate business models, including business strategies and policies, and behavioral tendencies are components of corporate culture, and also play an important role in shaping corporate decisions. Such influences interact in a dynamic system in which outcomes are nonlinear. As a result, nongovernmental influences can and have become dominant influences, overshadowing directives in law and the influence of higher fines and similar sanctions. Regulatory agencies in the U.S. have largely ignored these nongovernmental influences in shaping regulatory policy. The change, if any, in U.S. enforcement strategy is a greater emphasis on large penalties to deter future misconduct.[4] This continues to reflect a linear, reductionist view of corporate behavior. In contrast, regulatory authorities in the U.K. are rethinking their enforcement strategy based, in part, on recognition of multiple influences on corporate decisions, including cognitive influences.[5] In the U.S. this regulatory blindness seems likely to lead to recurring noncompliance.

To achieve the goal of deterrence, U.S. regulators must take the first step of recognizing the multiple influences on corporate decisions. In turn, regulators need to modify enforcement policies to reflect such multiple influences. Regulators must recognize that an increase in monetary penalties may not alone lead to consistent or resolute commitment to legal compliance. The challenge in the effort to achieve greater legal compliance is to determine how to modify enforcement policy to reflect the complex, dynamic nature of corporate decisions. The aim is to modify enforcement policy so that behavioral influences, including heuristics, incline the corporate actor toward greater commitment to compliance.

One possible change is an enforcement policy that makes greater use of market-based sanctions such as suspensions directed at the corporation in addition to other sanctions.[6] The suspension might be of a particular product, process, or line of business, and would alter the immediate assessments of risk. Faced with a business model emphasizing the importance of short-term profits and decisions that fail to account for risk, suspensions in lines of business, products or operations transform profits from primarily a benefit of noncompliance to a significant cost of noncompliance. The length of any suspension would be uncertain, magnifying the significance of the loss in a cost-benefit evaluation. Evidence of the effectiveness of this type of sanction is provided by the U.S. experience with the Community Reinvestment Act which imposes a similar sanction.

U.S. federal regulators have largely declined to impose corporate product, operations or line of business suspensions for legal violations,[7] although they have recently and occasionally imposed such measures when faced with violations of earlier settlements or recidivist behavior.[8] U.K. regulators have embraced this change in enforcement policy,[9] and it has been imposed by New York State’s financial regulator.[10] However, for this enforcement measure to be effective, consistency in resorting to suspensions is necessary.

Consistent suspensions is one of several changes in enforcement policy that would come from proper recognition of the complexity of and behavioral influences on corporate behavior. Ideally, a change in enforcement practices would interact with the many other influences on corporate behavior to encourage companies to comply with the law. How best to accomplish this goal requires further study.

ENDNOTES

[1] See generally Gretchen Morgenson, At Big Banks, A Lesson Not Learned, N.Y. Times (Dec. 12, 2014), http://www.nytimes.com/2014/12/14/business/at-big-banks-a-lesson-not-learned.html [https://perma.cc/2Z6Q-SFVR].

[2] Principles of Corporate Governance: Analysis and Recommendations § 2.01 (Am. Law Inst. 1994).

[3] Vincent Di Lorenzo, Business Ethics: Law As A Determinant of Business Conduct, 71 J. Bus. Ethics 275, 288 (2007).

[4] See generally Dep’t of Justice, Federal and State Partners Secure Record $13 Billion Global Settlement with JPMorgan for Misleading Investors About Securities Containing Toxic Mortgages, Justice Dept., (Nov. 19, 2013), http://www.justice.gov/opa/pr/2013/November/13-ag-1237.html [https://perma.cc/4JZH-2S4D].

[5] Fin. Servs. Auth., Enforcement Financial Penalties 5 (2009) (UK), http://www.fsa.gov.uk/pubs/cp/cp09_19.pdf [https://perma.cc/A7ZM-S2NL].

[6] See generally Vincent Di Lorenzo, Equal Economic Opportunity: Corporate Social Responsibility in the New Millennium, 71 U. Colo. L. Rev. 51, 94, 116-17 (2000).

[7] Citigroup, J.P. Morgan Chase, Barclays, and Royal Bank of Scotland pleaded guilty to criminal charges of conspiring to fix foreign currencies, but only after obtaining waivers from the SEC and the Labor Department allowing them to conduct business as usual managing mutual funds and managing pensions. See Neil Weinberg, JP Morgan’s Guilty Plea Puts Wealth Management Unit in Spot with Regulators, 104 Banking Rep. (BNA) No. 1044 (June 2, 2015); see Andrew Ackerman & Christina Rexrode, SEC Grants Bank of America Short-term Waiver from Hedge-Fund Restrictions, Wall St. J. (Nov. 25, 2014), http://www.wsj.com/articles/sec-grants-bank-of-america-short-term-waiver-from-hedge-fund-restrictions-1416959591 [https://perma.cc/NMW2-GL2J] (stating that waiver was granted to avoid sales restrictions in hedge funds, startups and other private offerings that would be triggered by fraud settlement regarding mortgage-backed securities); see Ben Protess, S.E.C Commissioners Split on Waiving Financial Industry Punishment, N.Y. Times (Feb. 4, 2015) http://dealbook.nytimes.com/2015/02/04/s-e-c-commissioners-split-on-waiving-financial-industry-punishment/?_r=0 [https://perma.cc/54DV-GY9M] (discussing that Oppenheimer has been the subject of at least thirty regulatory actions in the last decade, but was granted a waiver by the SEC from disqualification from private offerings after settlement of additional case involving securities misconduct).

[8] E.g., Jesse Hamilton, OCC Limits Servicing Rights Purchases: J.P.Morgan, Wells Fargo Among Targets, 104 BANKING REP. (BNA) No.25, at 1170 (June 23, 2015) (explaining how the Comptroller of the Currency restricted six lenders in their purchases of mortgage servicing rights because they have not met the terms of the 2013 settlements over mortgage foreclosure abuses);  Ben Protess & Matthew Goldstein, S&P to Pay Nearly $80 million to Settle Fraud Cases, N.Y. Times (Jan. 21, 2015) http://dealbook.nytimes.com/2015/01/21/s-p-to-pay-nearly-80-million-in-settlements/ [https://perma.cc/BWY3-37KN] (describing how Standard & Poor’s settlement with the SEC included a one-year “time out” from rating certain commercial mortgage investments, and involved improper behavior in 2011 that that “seems ripped from the same playbook that led S&P to help enable the mortgage crisis of 2008”).

[9] See Fin. Servs. Auth., Decision Procedures and Penalties Manual and Enforcement Guide Review (2010) (UK), http://www.fsa.gov.uk/pubs/cp/cp10_23.pdf [https://perma.cc/XE6L-2JSD]; Fin. Servs. Auth., Implementing Aspects of the Financial Services Act 2010, 17 (2010) (UK), http://www.fsa.gov.uk/pubs/cp/cp10_11.pdf [https://perma.cc/35XE-W9VQ]; Prudential Reg. Auth., THE PRUDENTIAL REGULATION AUTHORITY’S APPROACH TO ENFORCEMENT 23 (2016) (UK), http://www.bankofengland.co.uk/pra/Documents/publications/sop/2016/approachenforcementupdate.pdf [htps://perma.cc/E764-B5R5] at 35.

[10] See Danielle Douglas-Gabriel, Standard Chartered To Pay $300 Million for Violating Money Laundering Settlement, Wash. Post (Aug. 19, 2014), https://www.washingtonpost.com/news/business/wp/2014/08/19/standard-chartered-to-pay-300-million-for-violating-money-laundering-settlement/ [https://perma.cc/Q245-44MJ] (describing how Standard Chartered’s ability to conduct dollar clearing operations are suspended due to violations of its 2012 money laundering settlement). New York’s Department of Financial Services had earlier exacted a year-long suspension of its dollar-clearing operations from BNP Paribas in its settlement concerning violations of economic sanction laws. Id. Similarly, the New York Department of Financial Services imposed a two-year suspension on PricewaterhouseCoopers, a one-year suspension from consulting work at New York regulated financial institutions on Deloitte, and a six-month suspension on Promontory Financial. See Ben Protess & Jessica Silver-Greenberg, Promontory Financial Settles With New York Regulator, N.Y. Times (Aug. 18, 2015), http://www.nytimes.com/2015/08/19/business/dealbook/promontory-financial-settles-with-new-york-regulator.html [https://perma.cc/KLE8-PUWT].

This post comes to us from Professor Vincent DiLorenzo at St. John’s University School of Law. It is based on his recent article, “Corporate Wrongdoing: Interactions of Legal Mandates and Corporate Culture,”, available here.

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