One trend in recent years that has been impossible for anyone following the business pages to miss has been the steadily increasing numbers of huge monetary settlements that companies have reached with U.S. regulators and prosecutors. These settlements often involve staggeringly large amounts of money, often funded by shareholders. The Bank of America’s recent $17 billion settlement with the U.S. Department of Justice is merely the latest example. Yet the bases for these settlements and the justifications for the massive payments often are obscure. The settlements often arise because the companies must settle to avoid the potentially ruinous consequences of a trial; the settlements also allow enforcement authorities a basis from which to assert their regulatory effectiveness.
In the leader for the cover story in its August 30, 2014 issue (here), the Economist magazine asserts hat these attributes make the American regulatory system “the world’s most lucrative shakedown operation.” The vast range of rules and regulations to which businesses are subject means that even the most diligent company cannot be free of scrutiny. While there undoubtedly are companies whose activities merit censure and punishment, when the enforcement process takes place entirely behind closed doors and often depends for its basis more on the coercive power of the regulator rather than the merits of the case, the result is a “criminalization of corporate behavior in American” that is “bad for the rule of law and for capitalism.”
By any measure, the numbers of regulatory and prosecutorial actions filed against companies has grown at an alarming rate in recent years, as has the size of the fines and penalties imposed. The legal bases for government action range across a broad range of topics, including antitrust, bank secrecy, trade sanctions, bribery, environmental or food and drug safety, and consumer lending requirements. As the Economist says in its cover article (here), the “deeply troubling” result is that “companies are ever more frequently treated as criminals,” yet the crimes they are accused of “are often obscure and the reasoning behind the punishments opaque.”
Among other things, these governmental enforcement activities raise questions “about the role of the state as an increasingly active participant in many areas of business.” The article quotes a forthcoming book by University of Virginia Law Professor Brandon Garrett as saying that the enforcement activity represents an “ambitious new approach to governance,” in which governmental enforcement authorities “help to reshape the policies and cultures of entire institutions” based on complex agreements between prosecutors and companies,” governing new compliance procedures, curtailment of business activities and operational and managerial changes.”
Even more troubling are the uses to which the monetary recoveries are being put. The article cites examples showing how regulators and prosecutors view their corporate enforcement activities as, in effect, a profit center. Rhode Island’s attorney general’s office was, for example, able to fund a significant expansion of its office facilities as a result of the proceeds of a settlement with Google. A settlement earlier this year involving BNP Paribas set off an unseemly squabble among New York officials eager to hive off a larger portion of the settlement proceeds. As the Economist puts it, “why a state government should get any share at all of a French firm’s fine for defying a federal government’s foreign policy is not clear.”
In a January 2014 Harvard Law Review article entitled “For-Profit Public Enforcement” (here), Duke University Law School Professor Margaret Lemos and New Mexico Law School Professor Max Minzner argue that “public enforcers often seek large monetary awards for self-interested reasons divorced from public interest in deterrence. The incentives are strongest when enforcement agencies are permitted to retain all or some of the proceeds of the enforcement – an institutional arrangement that is common at the state level and is beginning to crop up in federal law.” In a system where companies calculate that they have no choice but to try to reach a settlement from which the enforcement authorities themselves will benefit, the process can begin to resemble what the Economist describes as a “shakedown.”
The “most troublesome” aspects of these enforcement developments are the “secrecy and opacity.” Because the cases almost always settle and never go to court, precedent is not established, “so it is unclear what exactly is illegal,” which in turn enables “future shakedowns” but “hurts the rule of law and imposes enormous costs.” Even with respect to the most culpable companies, the system is a failure, as it allows the companies and their senior officials to evade the scrutiny and censure that would follow “an unequivocal criminal conviction.”
These circumstances create enormous challenges for companies. Given the vast numbers of regulations to which companies are subject, the costs of compliance involved are huge. Yet, as the article states, “even the most diligent company may not escape censure.” The article quotes Larry Thompson, a former U.S. attorney general as saying that “no matter how gold-plated your corporate compliance efforts, no matter how upstanding your workforce, no matter how hard one tries, large corporations today are walking targets for criminal liability.”
The vast array of regulation to which companies are subject raises another problem, which is that the rules are so numerous and complex that “enforcing them becomes discretionary.” The discretionary nature of enforcement authority not only undermines the “predictability and clarity” that “serve as the foundation of the rule of law,” but it also “risks the prospect of a selective – and potentially corrupt system of justice in which everybody is guilty of something and punishment is determined by political deals.”
The Economist article paints a vivid and disturbing picture, but offers relatively little in the way of remedies. The article suggests only briefly, and without elaboration of how the suggested remedies are to be brought about, that the division between civil and criminal law should be more faithfully maintained, and that the excessive amounts of regulation should be cut back in the interests of clarity. With relatively little focus on the remedies but with a closing observation that perhaps the situation is, if anything, getting worse, the article’s overall effect is chilling.
The magazine’s cover refers to the “Criminalization of American Business,” but there is a very important sense in which this description is inaccurate. The article neglects to mention that often many of the targets of the U.S. enforcement activity are non-U.S. companies. U.S. regulators may indeed be criminalizing businesses, but often the companies involved often are not, as the article’s title would suggest, American. The list of companies mentioned by name in the article silently makes the point; among the companies named in the article are BNP Paribas, BP, Standard Chartered, HSBC, Credit Suisse, UBS, Barclays, Toyota, Marubeni, and Rabobank. While there are also many U.S. companies named as well, the significant number of non-U.S. companies involved is potentially troublesome and opens the regulators to potential questions of whether their regulatory activities are selective or whether they are targeting foreign competitors. At a time when many Western companies and governments are expressing alarm over the way China is targeting non-Chinese companies for, among other things, antitrust, environmental and corruption enforcement, the apparent propensity of U.S. regulators to target non-U.S. companies represents a potential problem.
Another aspect of the problem that the article does not address is the fact that regulators around the world have been paying attention, and are in fact attempting to borrow some strategies from the U.S. regulators’ playbook. As mentioned, China is newly assertive in extracting fines, particularly from Western companies. European authorities have also become increasingly active in enforcing and seeking fines under antitrust, privacy, taxation and anti-bribery laws. In August, automobile racing mogul Bernie Ecclestone agreed to pay $100 million to secure the discontinuance of bribery proceedings pending against him in Germany. The problems detailed in the Economist article are most advanced in the U.S, but the problems are not limited just to the U.S., and increased regulatory enforcement activity, often motivated by the same objective as U.S. authorities, is a growing problem around the world.
This brave new world of coercive regulatory enforcement has important repercussions for D&O insurance. The increasing activity of regulators, both inside the U.S. and around the world, has resulted in a significant increase in claims activity. To be sure, many of the significant monetary costs arising from this regulatory activity are not insured or insurable; the massive fines and penalties the targeted companies pay would not be covered under the typical D&O insurance policy. However, the defense expenses involved, which often are also massive, may be insured in whole or in part, at least where individual directors and officers are named as defendants in regulatory actions. By the same token, however, significant questions can arise when the corporate entity is the only defendant or when the regulatory action does not involve alleged violations of the securities laws (as entity coverage is often limited to alleged violations of the securities laws only). Difficult questions also arise with respect to defense expenses incurred during the phase when potential violations are under investigation and have not yet ripened into an actual enforcement action.
One sidelight on these issues that should not be overlooked is that the governmental enforcement actions can also lead to follow-on civil actions. Indeed, it is increasingly clear that the follow-on civil suit can arise – in the U.S., at least — whether or not the enforcement action arises in the U.S. or outside the U.S. To cite two recent examples, earlier this year investors filed securities class action lawsuits in the U.S. against Nu Skin Enterprises (refer here) and China Mobile Games and Entertainment Group (refer here) following anticorruption enforcement actions in China. Setting aside the question of the D&O insurance implications of the initial governmental enforcement activity, these follow-on civil actions clearly would implicate the involved company’s D&O insurance policies.
The battle lines on these questions about the scope and availability of D&O insurance coverage have already been drawn and are likely to become more fraught as regulatory and enforcement activity increases. For insurance buyers, the increased regulatory and enforcement activity has important implications as well, particularly with respect to questions of limits selection and limits adequacy, among other things. For the D&O Insurers, the increased regulatory and enforcement activity raises important questions about pricing adequacy and about the limits of underwriting. For both buyers and insurers, the regulatory and enforcement activity may raise important questions about policy terms and conditions, as the marketplace grapples with the issues of how much of the costs associated with this regulatory activity should be within the scope of the insurance.
The solutions to the problems described in the article likely are political. The political solutions may be a long time coming, as all too often bashing business is a convenient talking point for populist politicians. It may be that eventually, as the global financial crisis recedes further into the past, that the pendulum may swing the other way. In the meantime, regulators’ coercive enforcement powers will present a significant challenge for all companies, not just those based In the U.S. These issues have many important implications, and among many other things, present important issues for the D&O insurance industry.