The undercivilization of corporate law.

• Author: Hurt, Christine

1. INTRODUCTION II. THE OVERCRIMINALIZATION OF CORPORATE LAW A. Defining "Overcriminalization" B. The Cycle of Underenforcement and Overenforcement in Corporate Law C. Regulatory Responses to Perceived Increases in Corporate Misconduct 1. Sarbanes-Oxley Act of 2002 a. New Criminal Provisions b. Enhanced Criminal Penalties 2. Amendments to Federal Sentencing Guidelines a. Fraud, Theft, Property Destruction b. Enhancement for Officers or Directors of Publicly Traded Companies c. Added Loss Categories d. Obstruction of Justice e. Organizational Sentencing Guidelines 3. Corporate Fraud Task Force D. The Cycle of Overcriminalization Ends: What Happens When the Pendulum Swings Back III. DECREASING SHAREHOLDER RELIEF OR "THE UNDERCIVILIZATION OF CORPORATE LAW" A. Private Shareholder Litigation B. Fiduciary Duty Claims 1. Procedural Hurdles 2. Business Judgment Rule C. Securities Fraud Claims 1. Private Securities Litigation Reform Act of 1995 2. Dura Pharmaceuticals, Inc. v. Broudo 3. Empirical Studies of Post-PSLRA Effects IV. CAPITAL MARKETS AS AN ALTERNATIVE TO CRIMINALIZATION OR PRIVATE LITIGATION V. RECENT RESPONSES TO PERCEIVED INCREASE IN CORPORATE MISCONDUCT A. Criminal Prosecutions 1. WorldCom, Inc.--From Intent to "Willful Blindness" 2. Rite Aid--The Power of the Wiretap and a Plea Bargain 3. HealthSouth Corp.--Getting Another Bite at the Apple 4. Enron Corp.--Using the Domino Theory 5. Dynegy, Inc.--Paying the Price of Going to Trial 6. Cendant Corp.--Third Time's a Charm 7. Westar Energy--No Stone Left Unturned in Haystack Search B. New Horizons VI. THE PROSECUTORIAL TOOLBOX V. PRIVATE LITIGATOR'S BUNDLE OF RIGHTS A. Historic Criminal/Civil Balance B. Criminal Prosecutions v. Private Causes of Action 1. Aiders and Abettors; Conspiracy 2. Cooperating Witnesses 3. "Cooperation" 4. Broad Criminal Provisions 5. Multiple, Overlapping Charges 6. Second-Order Crimes 7. State of Mind 8. Pushing the Legal Envelope 9. One More Bite at the Apple 10. Damages, Part I: No Harm, But Still Foul 11. Damages, Part II: Calculating Damages 12. Damages, Part III: Sentencing Disparities VII. CASE STUDY: MARTHA STEWART/MARTHA STEWART LIVING OMNIMEDIA, INC. A. The Fact Scenario B. The Criminal Case C. The Shareholder Suit D. Martha Stewart Goes to Prison: Type One Error? VIII. CASE STUDY: PEREGRINE SYSTEMS, INC. A. The Fact Scenario B. The Criminal Case C. The Shareholder Lawsuits: Type Two Error? 1. Securities Law Class Action Suit 2. Shareholder Derivative Suit 3. California Insider Trading Suit IX. IS THE SYSTEM BROKEN? WHAT IS THE PERFECT CORPORATE LAW MOUSETRAP? A. Who Gains When Corporate Officers Meet the Criminal Law? 1. Monetary Relief 2. Deterrence as an Investor Benefit 3. Investor Confidence as an Investor Benefit 4. Parallel Prosecutions as an Investor Benefit B. Arguments Against Corporate Prosecutions 1. Resources 2. Error Correction 3. Incentives to Plead Guilty C. Who Gains When Corporate Actors Pay Civil Settlements or Judgments? 1. Monetary Relief 2. Deterrence 3. Proportionality D. Arguments Against Private Litigation 1. Myth of Vexatious Lawsuits 2. Intra-Shareholder Wealth Transfer 3. Difficulty in Measuring Damages 4. The Attorney Fee Conundrum X. CIVILIZING CORPORATE LAW XI. CONCLUSION INTRODUCTION

   In recent years, regulators, industry participants, practitioners, and academics have debated the causes of and cures for corporate misconduct. In the aftermath of the bursting of the technology bubble, and the disclosures of accounting irregularities (1) in the early part of the decade, citizens and their representatives have attempted to redress corporate wrongs in both civil lawsuits and criminal prosecutions. (2) Because of the convergence of many factors, including the creation of the Corporate Fraud Task Force and new federal sentencing laws, the choice of criminal prosecution seems to have become a popular path of corporate discipline, as reflected in its frequency of use by federal prosecutors. (3) However, following guilty verdicts in high-profile corporate criminal cases that resulted in lengthy prison sentences for individuals with no criminal records, commentators have complained about the "overcriminalization" of corporate law. (4) Critics argue that the types of misconduct in question in these cases, such as nondisclosure, bad decision making, conflicts of interest, opportunism, and violations of technical banking rules and flexible accounting principles, are manifestations of the principal-agent problem that are better corrected by other means, specifically the civil system or capital markets. (5) Moreover, recent appellate reversals of convictions and reductions of sentences have shed doubt on these prosecutions. However, what these otherwise persuasive arguments do not address is the fact that the current civil system does not easily offer redress for these principal-agent problems. (6) Due to incremental changes in both federal and state law, victims of corporate misconduct, former and current shareholders, face substantial obstacles in obtaining relief based on investor losses, (7) which are increasingly seen as foreseeable costs of investing in a risky environment. (8) These obstacles result in only the largest corporations associated with the largest investor losses facing any fear of successful private litigation, because only cases against these firms have a high expected value to a contingency fee attorney. (9) Ironically, civil lawsuits have the greatest chance of success when a parallel criminal prosecution is also pursued; corporate officers who are convicted generally settle civil lawsuits shortly thereafter because of the collateral effect of the criminal conviction. (10) However, once the current, and possibly waning, fervor for prosecuting high-profile corporate defendants abates, shareholder plaintiffs again will face a civil system designed to keep most lawsuits from proceeding, with little attention to the substantive merits. The civil litigation system, frequently seen either as an alternative to criminalization of corporate law or as a reason for its underenforcement, (11) serves as a weak substitute for criminal prosecutions. Therefore, what the current dialogue regarding overcriminalizing corporate law is lacking is a parallel complaint about the "undercivilization" of corporate law.

   Under the same set of facts suggesting corporate misconduct, public and private actors can seek to discipline the bad actors and provide a remedy to the victims of the misconduct in four major ways. (12) Federal and state prosecutors may investigate the misconduct, indict individuals and possibly the entity, and seek convictions under existing laws, including securities laws. (13) In addition, investors who bought shares of the firm during certain times may bring a cause of action against the firm for a violation of securities laws in connection with the purchase and sale of those shares. Current shareholders may also choose to bring a state law cause of action against directors and specific officers for violations of fiduciary duties that such actors owed to the firm. Finally, the Securities and Exchange Commission (SEC) may investigate and bring a civil action--either a judicial action or an administrative action--against the firm or individuals for violations of securities laws. (14)

   Participants in the capital markets should desire that one or more of these paths will be effective in both deterring future corporate misconduct and in providing restitution or other relief to anyone harmed by that misconduct. However, whether criminal penalties or civil penalties provide greater deterrence is empirically unknown and perhaps undeterminable, (15) and therefore beyond the scope of this analysis. Nonetheless, participants in the capital markets should also prefer that these systems obtain a reasonable balance between ensuring that culpable corporate misconduct is punished, while at the same time preventing innocuous corporate misconduct from not being punished. A system that allows the nonculpable to be punished can be described as having Type I errors, and a system that allows the culpable to go unpunished has Type II errors. (16) This Article examines characteristics of both criminal prosecutions and private litigation under this type of analysis. Because no system is perfect, lawmakers must determine which type of error is more palatable and adjust pleading burdens, evidentiary burdens, and presumptions accordingly. Historically, the relative burdens and defendant protections have reflected a concern that false criminal convictions, Type I errors, have greater negative utility than either Type I errors in the civil system or Type II errors in the criminal system. (17) Accordingly, criminal convictions have traditionally been more difficult to obtain than civil judgments for the same misconduct. (18)

   This Article argues that this balance between criminal prosecutions and civil litigation no longer holds in the corporate arena. Currently, the U.S. system for disciplining corporate misconduct has the worst of both worlds: a criminal law system that produces Type I errors, and a civil law system that produces Type II errors. (19) Many aspects of criminal law that favor the prosecution's quest to the detriment of the defendant's presumption of innocence suggest that corporate prosecution is the path with the greatest likelihood of "success" measured in terms of the probability of a guilty verdict. (20) Moreover, private litigation brought by investors has become greatly disfavored in the law. One only has to look at recent congressional enactments, such as the Private Securities Litigation Reform Act (PSLRA) (21) and the Securities Litigation Uniform Standards Act (SLUSA), (22) to see examples of the obstacles that investors face in bringing actions against companies in which they invest under either federal or state securities laws. In addition, cases brought in Delaware alleging...