In a ruling that has gained a great deal of attention and scrutiny, Southern District of New York Judge Jed Rakoff rejected the “neither admit nor deny” settlement in the SEC’s enforcement action against Citigroup, a ruling that is now on appeal in the Second Circuit (about which refer here). Among other things, Judge Rakoff’s ruling raises the question of whether or not settlements of SEC enforcement actions should be permitted without some type of admission of guilt or wrongdoing.


In a May 29, 2012 Dealbook blog post entitled “Why S.E.C. Settlements Should Hold Senior Executives Liable” (here), two University of Minnesota law professors, Claire Hill and Richard Painter, suggest that in order to increase the effectiveness of SEC enforcement actions, rather than requiring an admission of guilt, “a more effective approach would be to make senior, highly compensated officers of the bank pay some portion of the fine.”


The authors suggest that officers making more than $1 million a year “should be personally and collectively liable for paying a significant portion (perhaps 50 percent) of S.E.C. fines levied against the bank.” The authors add that independent directors should supervise negotiations with the S.E.C., and if the case is litigated rather than settled, the officers should be personally responsible for a portion of the bank’s legal fees. Banks should be prohibited from reimbursing the officers for the amounts the officers pay. The authors propose that the officers should be personally liable for fines whether or not the bank admits to liability.


In support of this proposal, the professors point out that under current practice, fines effectively are paid by shareholders, who “neither caused the behavior that led to the fine nor were they responsible for preventing it.” The authors also point out that many of the investment banks formerly did business in partnership form, which ensured that when there was a loss, the most highly paid partners suffered the most.


I have a number of concerns about the authors’ proposal. In commenting on their proposal, I do not in any way mean to minimize their observation about how the costs settlements are now imposed on shareholders. I agree that there are very serious questions that need to be addressed. However, I disagree that forcing corporate officers to bear personal liability for corporate fines is an appropriate solution. I want to stress at the outset that in offering my views here, I mean no disrespect to the Professors or their article. I mean only to present a contrasting point of view.


First, it appears that, though not expressly stated in their article, the authors proposal is directed specifically and exclusively toward companies in the financial sector. Indeed, it appears that in proposing their solution the authors were thinking only about investment banks, perhaps because they made their proposal in the context of the Citigroup settlement controversy. However, the authors do not provide any principle whereby their proposed solution would (or could) be limited just to the investment banking sector. If this proposal is fair for officers of investment banks, then it ought to be fair if applied to any publicly traded company. And if it would not be fair for other companies, it would not be fair for investment banks – it not enough simply to say it is fair because investment bankers make a lot of money.


Second, it is also not expressly stated in their article, but it appears to me that the authors intended that the officers should be held personally liable for corporate fines regardless of whether the officers had any involvement in or even awareness of the alleged wrongdoing – and indeed whether or not the bank itself has admitted to any wrongdoing.   In other words, the authors seem to be suggesting that the officers should have to pay a portion of the fines not because of any actual or even alleged culpability, but simply as a matter of their status. Indeed, the officers have to be prepared to pay out of their own pockets if they want to fight the charges even if they themselves are not charged with any wrongdoing.


As I have stated before on this blog (most recently here), I think there is an increasing and unfortunate tendency to try to impose personal liability in corporate officers without regard to culpability. Among other things, an increasing and indiscriminate use of the “responsible corporate officer” doctrine has been used to impose personal liability on corporate officers for fines involving healthcare and environmental violations. Statutory provisions such as the Sarbanes Oxley compensation clawback provisions similarly have been used to impose liability on corporate officials whose companies restate prior financials, regardless of whether the officers themselves had any actual or even alleged involvement in the circumstances that required the restatement. 


I am concerned that a generalized presumption that corporate executives as a group or class are somehow blameworthy and deserving of liability is behind this trend toward imposing liability on corporate executives without actual culpability. There is an unfortunate trend in our society to assume that when something has gone wrong that somebody has to be punished. This general proclivity to look for someone to blame is exacerbated by a general willingness to demonize corporate “fat cats,” which in turn leads some to conclude that corporate executives deserve liability because of their position, without regard of whether they actually did anything culpable.


The authors’ proposal to impose personal liability on investment bankers simply because of their pay grade embodies all of these concerns. It overlooks any notion that liability in our legal system ought to be premised on culpability. Moreover, there seems to be a suggestion that because investment bankers are highly compensated, liability can fairly be imposed on them even if it might not be fairly imposed on comparable officials at other types of firms or under other similar circumstances.  


It is not an answer or justification for this approach that investment banks formerly did business as partnerships, in which partners bore losses personally. These firms long ago stopped doing business in that form, and chose to do business as corporations precisely because there are advantages to doing business in corporate form. There is absolutely no reason why investment banks doing business in corporate form are any less entitled to the protection of the corporate form than any other type of business doing business as a corporation. There is no reason to overlook the corporate form and impose corporate liability on individual officers simply because officers at the investment bank are highly compensated.


Let me come at this from a completely different direction. Many recent law school grads and many commentators have noted that recent law school graduates have had trouble getting legal employment. There are many causes to this problem. One might suggest that the law schools would be quicker to find solutions to this problem if law professors had to give back a portion of their compensation paid to them during the period when the unemployed law students were enrolled at the school. I suspect that law professors would see many problems to this kind of “solution” – it isn’t their fault that the students can’t get employment; their compensation has no relation to the students’ employability; they themselves never promised that the students would get employment, and so on.


Many of the same obvious objections to the modest solution about law professor compensation clawbacks are equally applicable to the authors’ proposal about the investment bankers’ personal liability for corporate activity. The point is that the imposition of penalties without culpability is fundamentally unfair, and this fairness is not eliminated simply because the persons on whom the fines would be imposed are highly compensated. When investment bankers are viewed as mere abstractions, as corporate fat cats lighting cigars with hundred dollar bills, it is easy to propose penalties and impositions on them that would not be considered fair in any other context. It is easy to ignore basic constraints such as the notion in our society that there should be no liability without culpability, or that corporations are legally separate from the persons who run them.


If there are problems with the way investment bankers are compensated, well, fine, let’s discuss that issue. But even if investment bankers’ compensation needs to be addressed, that is no reason to deprive them of the same protections of fair play that to which everyone else is entitled.


I appreciate that many believe corporate executives need to be held more accountable. Nevertheless, I am concerned that as a result of the increased tendency to try to impose liability on corporate executives without culpability, there is a contrary danger that corporate executives could be held liable too frequently, or at least in instances when they have done nothing themselves to deserve it. Scapegoating any individual – even a highly paid investment banker – for circumstances in which they were not involved and of which they were not even aware is inconsistent with some of the most basic assumptions of a well-ordered society governed by law.


Lady Justice carries a sword. But she also carries scales that are evenly balanced. And she is blindfolded. It should not matter who stands before the law. .


Tiananmen Square Remembered: Yesterday, June 4, 2012 was the 23rd anniversary of the date in 1989 when the Chinese authorities violently cleared Tiananmen Square after six weeks of protests and demonstrations there. In recognition of the anniversary, the Atlantic Magazine online published a gallery of photos from Tiananmen Square, then and now. The pictures, which are fascinating and moving, can be found here


Given the violence of the suppression, it is hardly surprising that no one in China wants to talk about those events now. But it is remarkable observing in the photos how many people were involved in the demonstrations. A lot of the people who (understandably) won’t talk about it now were marching in the streets then.


I know from my April visit to Beijing that the Square itself is now full of tourists and aspiring capitalists trying to sell genuine Rolex watches to foreigners, and that the street between the Square and the Forbidden City is now full of tour busses, SUVs, and taxi cabs. And also government officials speeding past in Audi A6s with tinted windows.


About the Title of This Post: The title of this post is a reference to a line from Voltaire’s Candide. At that time, England had notoriously executed Admiral John Byng for “failing to do his utmost” during England’s naval defeat at the Battle of Minorca, at the outset of the Seven Year’s War. In Voltaire’s book, the main character, Candide, witnesses the execution in Plymouth, and is told that "in this country, it is good to kill an admiral from time to time, in order to encourage the others." (Dans ce pays-ci, il est bon de tuer de temps en temps un amiral pour encourager les autres).