Deferred Prosecutions in the Corporate Sector: Lessons from Libor

• Publication year: 2013

SEATTLE UNIVERSITY LAW REVIEWVolume 37, No. 2, Winter 2014

Deferred Prosecutions in the Corporate Sector: Lessons from LIBOR

Justin O'Brien(fn*) & Olivia Dixon(fn**)

I. INTRODUCTION

Since 2008, the global economic downturn has significantly increased operating pressures on major corporations. Profit margins have been squeezed. Increased competition, decreased demand, and the perennial pressure to meet or exceed earnings forecasts add to the bottom line pressures on corporate boards. The 2012 Ernst & Young Annual Global Fraud Survey (Ernst & Young Survey) paints an exceptionally bleak picture.(fn1) It details a debilitating nexus between a challenging economic outlook and "institutional fatigue," which inhibits capacity to deal with a pervasive and growing problem.(fn2) Hard times, it concludes, strain ethical standards.(fn3) Significantly, this increased corporate tolerance for corruption coincides with a marked preference by regulators in settling, rather than litigating, enforcement actions.

This trend is most notable in the United States, where fines linked to deferred prosecution agreements (DPAs) have been running at record levels.(fn4) Most recently, focus has shifted to corruption in the setting of benchmark interest rates, where at least sixteen banks and three brokerage houses are currently under investigation by regulatory authorities over the suspected manipulation of the London Interbank Offered Rate (LIBOR).(fn5) To date, the United States has levied just over $1.8 billion(fn6) in penalties from three banks that have executed negotiated settlements. These agreements, which amount to extrajudicial contracts, significantly enhance the bargaining power of prosecutorial agencies. The flexing of regulatory and legal muscle is also apparent in the United Kingdom, where the Crime and Courts Act 2013 (CC Act)(fn7) introduced into U.K. law for the first time the concept of deferred prosecutions.(fn8)

The justification offered by the United Kingdom for the introduction of deferred prosecutions, as set out in the Ministry of Justice consultation paper,(fn9) is the capacity of the mechanism to enforce behavioral change.(fn10) In particular, the consultation paper highlighted how efficacious deployment of external monitors through deferred prosecutions can be in evaluating ongoing corporate commitment to the introduction of remedial measures.(fn11) Three additional tactical and strategic advantages were also canvassed. First, it can reduce the time it takes to complete complex investigations.(fn12) Second, and if appropriate, demands for corporate exit from particular high-risk activities or markets can be built into the calculation.(fn13) Third, significant revenue can accrue to the Treasury, therefore adding to the sovereign balance sheet as well as to the prosecutorial armory. (fn14)

In both the academic and practitioner communities, the expansion of prosecutorial authority is greeted with markedly different responses on either side of the Atlantic.(fn15) In part, this can be traced to substantial variation in enforcement priorities, past performance, and the availability of liability-reducing defenses. For example, with respect to allegations of foreign bribery, the United Kingdom's Bribery Act 2010 (Bribery Act)(fn16) closely tracks the United States' Foreign Corrupt Practices Act of 1977 (FCPA)(fn17) in its definition of what constitutes an offense; however, the Bribery Act departs substantially in that corporate liability can be reduced if "adequate procedures" are in place.(fn18) The relatively sanguine nature of the response in the United Kingdom also reflects the prior catastrophic failure of the Serious Fraud Office as an effective prosecutorial agency.(fn19) This has led to an underestimation of the risks associated with providing these agencies with the power to broker settlements.

This Article argues that the expansion of prosecutorial authority without appropriate accountability restraints is a major tactical and strategic error. It examines the benefits and pitfalls of using the deferred prosecution mechanism to combat economic crime. It highlights the scope of its actual and proposed application. It assesses whether enhanced prosecutorial flexibility enhances or inhibits the capacity to enforce behavioral change. Finally, it evaluates whether the mechanism can be made subject to effective oversight. It argues that the current framework in the United States is highly problematic, leading to settlements that generate newspaper headlines but not necessarily cultural change. It also runs the risk of privileging a form of enforcement that operates outside appropriate legal safeguards. The approach canvassed by the British authorities offers only a partial improvement in this process. For negotiated prosecutions to be truly effective, they require a much firmer normative basis.

The Article is structured as follows: Part II outlines the growing scale of and tolerance for economic corruption as outlined in the Ernst & Young Survey. Part III explores how and why deferred prosecution has become the enforcement tool of choice in the United States, with particular reference to breaches of the FCPA and the recent LIBOR scandal. Part IV evaluates the accountability deficiencies associated with its application, both in terms of over-enforcement and under-enforcement. Part V evaluates the extension of the mechanism in the United Kingdom and assesses the extent to which the refinements address the accountability deficit. Finally, Part VI concludes.

II. THE CORRUPTION NEXUS

In the United States, corporate misconduct rarely gets litigated to a conclusion. Instead, prosecutorial authorities privilege negotiated settlements with deferred prosecution agreements being routinely applied to settle allegations of bribery and corruption under the FCPA.(fn20) While this approach generates headlines, it appears powerless to either stop the incidence of corruption or provide granular guidance on how to develop more effective compliance programs. At a global level, the Ernst & Young Survey is one of the most detailed snapshots of the bribery and corruption challenges facing multinational corporations currently undertaken. An understanding of the scale and tolerance for economic corruption is essential to explaining the proliferation of the U.S. Department of Justice's (DOJ) preference for utilizing deferred prosecutions. The survey is drawn from a sample of 1,700 senior executives.(fn21) It includes respondents drawn from incumbent chief financial officers (CFOs) and senior executives charged with running the legal, compliance, and internal audit functions of major corporations across forty-three different countries.(fn22) One of the most "troubling" findings is what Ernst & Young deems a growing widespread acceptance of unethical business practices-for example, 64% of respondents believe that the incidence of compliance failure has increased because of the downturn.(fn23) The trend is particularly apparent in East Asia-for example, 60% of respondents in Indonesia suggested it was acceptable to make cash payments to secure new contracts, and 36% of respondents in Vietnam suggested it was permissible to misstate financial accounts.(fn24)

The decline in ethical commitment is traced to a lack of training and, more significantly, to mixed messages from senior management as to the importance of compliance with Anti-Bribery and Corruption Policies (ABACP).(fn25) As Ernst & Young conclude, if action is not taken to hold offenders to account, stated commitment to high standards remains an exercise in symbolism.(fn26) It is also an exceptionally risky strategy given the global rise in enforcement. While many of the executives surveyed reported having sophisticated compliance systems in place, these systems were not subject to ongoing external testing.(fn27) Only 33% reported using external law firms or consultants to provide assurance.(fn28) In a significant finding, 54% of CFOs surveyed had not taken ABACP training,(fn29) while 52% of all respondents reported that the board was not sufficiently aware of operating risk.(fn30) As well as specific local conditions, the survey that found boards needed to be much more cognizant of the risk associated with corporate acquisitions.(fn31)

Unless gaps between controls and compliance programs in each entity are identified and procedures rectified, the conflation of existence of control and effective risk management could magnify, rather than resolve, the litigation threat.(fn32) However, the overriding identified risk, and resulting legal exposure, focused on how a corporation manages the legacy and ongoing relationships with third parties.(fn33)

According to Ernst & Young, "many companies are failing to adopt even the most basic controls to manage these third-party relationships"(fn34) (e.g., only 59% use an approved supplier database; 56% adopted a background checking system; 50% do not check the ownership structure of the third party as part of routine due diligence; 55% either do not have audit rights or check audit procedures with the third-party entity).(fn35) According to the global professional advisory firm, this constitutes a "real problem" precisely because third-party due diligence is "increasingly expected" by the DO J as well as the authorities in England and Wales.(fn36) Disturbingly, 15% of the CFO respondents report unawareness that the corporation can...