The failure of corporate governance standards and antitrust compliance.

Author:Markham, Jesse W., Jr.
Position:Antitrust and Competition in America's Heartland

    Antitrust policy in U.S. law ought to be promoted by two complementary bodies of law: the remedial provisions of antitrust law itself and the compliance obligations imposed on managers by corporate fiduciary law. Antitrust law provides specialized incentives to promote compliance. Automatic trebling of antitrust damages in civil case and fee-shifting for prevailing plaintiffs serve as in terrorem incentives for corporate managers to ensure that their employees comply with antitrust laws. Criminal antitrust sanctions, (1) including potentially large fines and incarceration, contribute another source of compliance incentives. In recent years, federal sentencing guidelines for organizational crimes, including criminal cartel offenses, magnify sanctions for failures to maintain "effective compliance" programs. (2) Civil antitrust risks are enormous and include not only the treble damages exposures but also the high costs of defending discovery-intensive litigation. In these various ways, antitrust remedial provisions are designed to deter violations and to encourage compliance. On the corporate law side, managers owe fiduciary duties of care, loyalty, and good faith to the company and its shareholders. These duties, as articulated in cases like In re Caremark International Inc. Derivative Litigation, (3) require corporate managers to make a good faith attempt to ensure that corporate activities under their supervision comply with applicable laws. Failure to discharge these fiduciary duties faithfully can expose board members and corporate officers to personal liability to the corporation through the mechanism of derivative litigation. (4) Since the company's losses resulting from antitrust violations can be substantial, director derivative exposures are commensurately high. Thus, the combination of antitrust law and fiduciary law potentially operates to advance the broad objectives of

    competition policy embraced by antitrust laws.

    In practice, however, both of these strands have failed to deter antitrust law violations, which continue to occur with disappointing frequency. Some reasons for this failure seem obvious enough. Ever-increasing monetary sanctions, both criminal and civil, place the risks and ultimate costs of unlawful cartel activity on unwitting shareholders rather than board members or senior managers. Since shareholders have no control over the conduct of corporate personnel, imposing the cost of employee noncompliance on shareholders cannot affect anyone's conduct. Furthermore, even if shareholders could influence corporate compliance policies, large antitrust fines barely affect the individual shareholders of public companies because the economic burden of the fine is so broadly dispersed. (5) Criminal monetary fines levied on corporate defendants thus provide no direct incentives for boards of directors to implement sufficiently effective compliance measures to counteract the powerful economic incentives to cartelize. The penalty, if the company's misconduct is even detected and successfully prosecuted, is borne by others who have no particular economic incentive to care very deeply.

    The failure of harsh antitrust sanctions is a consequence of their misdirection, loading burdens only on individuals who have no role ex ante in setting corporate compliance policy. For example, when Furukawa Electric Co., Ltd., recently agreed to pay a near-record $200 million criminal fine for price fixing in the automotive parts market, the payment out of the corporate treasury inflicted its most direct pain upon the owners of the company, not its board of directors or senior managers. (6) Three individual employees were also convicted under the plea bargain. These individuals had never had a role in fashioning corporate governance policy. They were managers of a sales division or a subsidiary of Furukawa. The three mid-level managers, Japanese nationals, agreed to plead guilty and to serve prison time in the United States ranging from a year and a day to 18 months. (7) None of the convicted individuals sat on (or anywhere near) the company's Management Council, which "sets the Furukawa Company Group's fundamental management policies and strategies and makes decisions on important matters." (8) Thus, no one who had been in a position to set overall corporate compliance policy was affected directly by the imposition of any sanction for the serious and persistent antitrust law violations that led to the convictions. Whatever "fundamental management policies" the company's Management Council established apparently did not include effective antitrust compliance training for the convicted employees, nor were information and reporting systems implemented that detected wrongdoing by lower level employees in a timely way. Ex ante, the members of the Management Council had no reason to fear adverse personal consequences from antitrust enforcers no matter how severe their neglect may have been. In this important respect, the sanctions imposed for these serious antitrust violations were misdirected at the shareholders and a few mid-level managers, all of whom were powerless to set corporate policy or to instill a corporate culture sincerely devoted to legal compliance. These misdirected sanctions fail to create incentives for governing boards to establish a sincere corporate culture of legal compliance coupled with effective systems to back up such a culture.

    Corporate governance law fails as well. The fiduciary duty applicable in the United States never placed much burden on boards to foster legal compliance, and even these skimpy standards have been eroded by courts and legislatures. Corporate governance standards present no meaningful risk--let alone any sort of in terrorem--to directors who have failed to promote compliance or detect and respond to employee misconduct. Among the fiduciary duties of care, good faith, and loyalty that corporate managers owe to the company and its shareholders is a duty to implement measures reasonably designed to ensure that the company's activities comply with applicable laws, as well as information and reporting systems designed to detect wrongdoing so that remedial steps can be taken. (9) The duties articulated in Caremark are rooted in the duty of care but also find their source in the duty of good faith. There is, however, almost no potential for personal liability for boards that fail to encourage antitrust law compliance. First, the duty of care, which is explicitly stated in most corporate codes as imposing a standard of ordinary care, has been re-written by the courts (especially in the influential courts of Delaware) to mean something like gross negligence. (10) A manager violates this standard of conduct only by acting irrationally and not merely by engaging in conduct that an ordinary person in like circumstances would avoid. (11) Second, the duty of care has almost no place in the life of a board member of a public company because every state of the Union has enacted so-called "exculpation" enabling laws that permit corporations to excuse their boards of any duty of care. (12) Thus, the already weak fiduciary standards are further undermined by the adoption of exculpation clauses in corporate governing documents. (13) The charters of most public corporations now contain these exculpatory provisions. All that remains is a vague duty of "good faith" which imposes on the board some sort of duty to implement legal compliance mechanisms. The standards of conduct are relaxed, at best.

    Furthermore, corporation law is one of the few areas in which the standards of conduct are divorced from the correlative standards of proof. The fiduciary standards of conduct are frequently stated in lofty terms, often with reference to Judge Cardozo's flowery prose:

    Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arm's length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the "disintegrating erosion" of particular exceptions.... Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. (14) Since Cardozo authored Meinhard v. Salmon in 1928, courts have not only diluted fiduciary standards of conduct, but they have divorced these standards from the standards of proof that apply when a fiduciary is challenged for a breach of fiduciary duty. Caremark is an example. There, the Delaware Chancellor Allen held that a board of directors' duty of loyalty required it to take measures reasonably suited to the objectives of legal compliance:

    [I]t would, in my opinion, be a mistake to conclude that.., corporate boards may satisfy their obligation to be reasonably informed concerning the corporation, without assuring themselves that information and reporting systems exist in the organization that are reasonably designed to provide to senior management and to the board itself timely, accurate information sufficient to allow management and the board, each within its scope, to reach informed judgments concerning both the corporation's compliance with law and its business performance. (15) Chancellor Allen then proceeded explicitly to uncouple this standard of conduct from the plaintiff's evidentiary burden of establishing a breach:

    In order to show that the Caremark directors breached their duty of care by failing adequately to control Caremark's employees, plaintiffs would have to show either (1) that the...

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