Corporate Counsel Organization Highlights GC Conference Considers Unintended Consequences Of Post-Enron Reforms

Friday, April 1, 2005 - 01:00

Editor: Bill, please describe the purpose of the Conference and why it is timely now.

Ide: Enough time has passed and experience accumulated since the post-Enron reforms to have a good feel for which reforms are working and which may need improvements. There is increased discussion in the in-house community that while many of the post Enron reforms have worked well, some reforms are creating unintended consequences that are becoming apparent. The purpose of the Conference is to discuss the issues surrounding the unintended consequences.

Editor: Bill, the purpose of this interview is to get your views on some of the issues to be discussed at the Conference.First, do corporations dare to seek their day in court without fear of retribution?

Ide: The approach of the Bush administration after the passage of the Sarbanes-Oxley Act was to "get tough" and appropriate large amounts of money for enforcement both at the Department of Justice and the SEC. The public was shown that government was holding people accountable. The concerns that are being raised now are that you almost have a self-sustaining martial law. The concept of martial law is to suspend the rules temporarily because of a crisis - but as soon as the crisis has passed, you put the rules back in place. First of all, there may not have been a need for government to suspend the rules such that the interpretations of them put Arthur Andersen out of business or required waiver of the privilege to be deemed cooperative.

Corporations are nervous now, because the crisis has passed but the rules are not being put back in place. They still operate under a potential threat that because of the misbehavior of a few, they can be put out of business with tens of thousands of innocent people losing their jobs. They can still be forced to waive the attorney-client privilege. They have been told not to reimburse officers for defense costs or the corporation itself may become a target forå enforcement actions.

There is concern that business people are subject to prosecutorial caprice.They ask:Where is the clarity on how corporations can be deemed cooperative without waiving historic rights? Why should corporations be asked to pay sizable fines when it is the shareholders who suffer, not the individual wrongdoers?

Massive resources have been placed in the hands of the enforcement community. If the culture and environment that led to scandals has been fixed - for example, through corporate self-regulation with boards of directors having been empowered to take effective action - is there still the same need for such resources?

Editor: The crux of the debate about the attorney-client privilege seems to center on the government's contention that the privilege is only available to the corporate entity and that it is not applicable where it is invoked to protect employees and directors.

Ide: I expect that one of the highlights of the Conference will be discussion of the recently decided Second Circuit Court of Appeals decision. It concerns whether the former Governor of Connecticut's lawyer was able to claim the attorney-client privilege. The argument is that the government lawyer represented the public, and therefore the public was entitled to full waiver of the privilege. If you substitute the word shareholder for public, you have a direct analogy to the corporate world. The Second Circuit decided that the government operates through its officials and for the officials to be effective, they need counsel and for counsel to be effective, they need the privilege. It will be interesting to see what effect this decision has on the debate as to the appropriateness of regulators demanding waiver of privilege by public companies.

Editor: Are companies being overwhelmed by accounting minutiae?

Ide: The major issue concerns the relationship between the audit committees and the auditors. The audit world has new dynamics: risk management now drives auditor behaviors as does the fact that auditors have lost consulting fees as a source of revenue. Some argue that the audit community has hijacked Section 404 with overcautious risk concerns and the temptation to seek consulting replacement revenues.There is also no guidance on materiality - at some point the cost of leaving "no stone unturned" exceeds the benefits of micro-level review to the corporation and it shareholders.A number of commentators have indicated that the tremendous costs generated by Section 404 cannot be justified from a policy point of view. Clearly, Section 404 imposes a heavy burden on smaller companies.

Editor: Has director liability been increased to a point where the most qualified people are becoming reluctant to serve?

Ide: The big question is whether people can afford to be directors now. The psychic income is about the only way to justify the risk and that's not a sound business approach. The proposed WorldCom and Enron settlements have gotten a lot of attention.Directors that have been sued and lawyers that handle their defense complain about the weakening of the "business judgment" rule. The issue is whether there are now so many uncertainties in the law that directors are almost always forced to settle.In addition, more and more you are seeing insurers reserving their rights against directors because they have been hit so heavily. It is a nervous time to be a director.

The Conference will discuss whether we should further reform the civil justice system to allow directors greater comfort that they can get out of meritless suits by motions to dismiss or a motion for summary judgement.There will be a discussion of a need to clarify further the "business judgment" rule by more precisely defining the "good faith" condition.

Editor: Has too much power been placed in the hands of prosecutors?

Ide: Substantial resources have been allocated to the enforcement community as a reaction to the Enron and other scandals. We all applaud the high profile suits brought against people tied to large frauds. The question is whether we have passed the time when corporate misbehavior can only be curbed by aggressive prosecutors and the threat of punitive civil litigation.We have numerous examples today of directors moving quickly and effectively to remove tainted CEOs from the executive suite. Perhaps, the reforms at the board level have created the best way to reach today's problems.There also is no longer a premium placed on prosecutorial restraint.Current budget levels, when coupled with the enforcement competition among the federal and state governments, may create an incentive to prosecute even though the issues are being addressed by effective self-regulation.

Editor: Is obstruction of justice being overused as a basis for attacking corporate wrongdoing?

Ide: When concern about the Enron era scandals were at a peak, the enforcement community felt that they saw situations where the prosecutorial targets that ran the company and their underlings sought to hide the facts and obstruct justice. Given the web of regulations that have since resulted from Sarbanes-Oxley, it is unlikely that corporate wrongdoing can still be concealed as effectively. There also seems to be growing public concern that attribution of an act of obstruction by an individual can be used to bring down an organization even though other acts of wrongdoing by the organization cannot be proven.

The classic case would be Arthur Andersen. That was a wonderful company with a great history, and because of the decision to hold the entity accountable for the acts of a few by the enforcement community, Arthur Andersen is not here today. A lot of innocent people suffered.

Editor: Has the flood of civil litigation been counterproductive?

Ide: The big scandals involving rampant fraud seem to be pretty much behind us.We are now seeing a rash of restatements triggered by technical accounting issues brought to light as a result of Section 404 reviews - such as whether a reserve is appropriate or a particular expenditure should be expensed or capitalized. Clearly, there has been a tightening of the rules and this generally has been productive.The problem is that every time there is a restatement, there is a corresponding drop in the stock price and a lawsuit. Most of these lawsuits do not involve fraud. Yet directors and officers find it difficult to mount successful defenses because the traditional procedural defense mechanisms have been weakened.We are seeing cases being pursued that should quickly have been disposed of through a motion to dismiss or motion for summary judgment.Potential exposure to such litigation deters the best people from serving as directors and distracts officers from concentrating on the goal of enhancing shareholder value.The Conference will discuss ways that this litigation burden might be reduced.

Editor: Can corporate governance reforms be a litigation deterrent?

Ide: Good corporate governance includes placing an emphasis on self-regulation and putting in place the mechanisms to make self-regulation effective. It means having a strong legal function, a code of conduct, employee compliance training programs, an effective compliance hot line and a willingness to pursue internal investigations of wrongdoing. As self-regulation continues to demonstrate that less government intervention is necessary, conditions will be created for rolling back government intervention in the business sector.It is essential that when business calls for reducing prosecutorial excess and changing laws that encourage civil litigation against corporations and their officers and directors, that they focus public attention on the great gains that have been made by corporations in governance and self-regulation. The business case will be strengthened as self-regulation takes hold because adverse publicity will be reduced by better control of compensation, improved risk management, and fewer restatements.

The model one can look to is the defense industry. In the 1980s the industry lost public confidence and there was potential that Congress was going to enact strict (some would say debilitating) regulatory oversight requirements. There was a decision among the defense contractors (with Congressional consent) that the industry would be better off self-regulating. That was the precursor to the Organizational Sentencing Guidelines, which form the basis for today's corporate compliance programs. Out of necessity, the defense industry was a leader with compliance programs, codes of ethics and hotlines. Hopefully, the Conference will send the message that this is a good (and necessary) model for all of corporate America.