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Corporate Liability for Insider Trading
CORPORATE CRIMINAL LIABILITY
FOR INSIDER TRADING
Howard J. Kaplan
Kaplan Rice LLP
New York NY
CORPORATE CRIMINAL LIABILITY FOR INSIDER TRADING
When will the Department of Justice indict a company based on the criminal acts of its
employees? This question raises an age old debate concerning whether a company itself should ever be indicted. As history demonstrates, the collateral consequences of such an indictment can be catastrophic for businesses in the financial services industry. Two notable examples were Drexel Burnham and Arthur Anderson, both major financial services firms that did not survive criminal convictions.
1 The government’s crackdown on insider trading has generally not targeted business entities. 1 Two recent exceptions are the indictment and guilty plea of S.A.C. Capital Advisors L.P.
(“SAC”) 2 and the plea agreement with Tiger Asia Management LLC (“Tiger Asia”). 3 The SAC matter in particular has caused substantial debate because the firm was indicted despite the fact that the government apparently lacked sufficient evidence to indict the firm’s founder and owner, Steven A. Cohen.
Was the SAC indictment in accordance with the Department of Justice guidelines regarding criminally charging business entities? The DOJ would certainly contend it was, with justification. 4 Nonetheless, when the SAC indictment was announced, some commentators criticized it, arguing that the indictment alone would destroy the company regardless of whether or not it was guilty. 5 Others praised the government’s decision. 6 Moreover, in several other cases, most notably the conviction of Morgan Stanley’s employee Skowron, the government considered the firm a victim of its employee’s crimes.
This article provides an overview of the guidelines for holding a company criminal responsible for the misconduct of its employees, and how such guidelines appear to have been applied in cases of insider trading.
1 For earlier examples, see U.S. v. Marcus Schloss & Co., Inc., 724 F. Supp. 1123 (S.D.N.Y. 1989); U.S. v. Teicher, 987 F.2d 112 (2d Cir. 1993).
2 U.S. v. S.A.C. Capital Advisors, L.P., 2013 WL 5913921, 2013 U.S. Dist. LEXIS 160216 (S.D.N.Y. Nov. 5, 2013).
4 The DOJ’s policies guidelines for determining whether to charge a business entity are set forth in United States Attorneys' Manual title 9 chapter 28. The factors to be considered are set forth at 9-28.300.
5 See, e.g., Burton Finance Blog, Guilty Until Proven Innocent, July 26, 2013 http://etbfinance.blogspot.com/2013/07/guilty-until-proven-innocent.html 6 John Gapper, The Criminal Indictment of SAC Is Right for Wall Street, Financial Times July 25, 2013 http://blogs.ft.com/businessblog/2013/07/the-criminal-indictment-of-sac-is-right-for-wall-street/?
“A corporation cannot commit treason, or felony, or other crime, in it's corporate capacity though it's members may, in their distinct individual capacities.”7 This was the early consensus view - that a corporation could not be held criminally liable for the acts of its agents. This view was based on the notion that corporations do not commit crimes, people commit crimes. While the position that business entities should never be held criminally liable still has its supporters, 8 this view was rejected by the United States Supreme Court early in the 20th Century, and today it is well established in the United States that a business entity can be convicted of a crime based on the acts of its employees.
The Supreme Court’s seminal case is New York Central & H.R.R. Co. v. United States. 9 Two railroad company managers illegally gave rebates to various sugar companies for shipping on their line. The managers and the railroad were all found guilty based on this conduct. The railroad appealed, arguing it was unconstitutional to hold the company’s shareholders liable for
the unauthorized crimes of company employees. The Supreme Court disagreed:
It is true that there are some crimes which, in their nature, cannot be committed by corporations. But there is a large class of offenses … wherein the crime consists in purposely doing the things prohibited by statute. In that class of crimes we see no good reason why corporations may not be held responsible for and charged with the knowledge and purposes of their agents, acting within the authority conferred upon them. 10 7 Blackstone's Commentaries on the Laws of England – Book One, Chapter Eighteen: Of Corporations.
8 See, e.g., John Hasnas, The Centenary of A Mistake: One Hundred Years of Corporate Criminal Liability, 46 Am.
Crim. L. Rev. 1329 (2009). United States District Court Judge Jed Rakoff of the Southern District of New York has also expressed skepticism about prosecuting entities rather than individuals. Jed Rakoff, Why Have No High Level Executives Been Prosecuted In Connection With The Financial Crisis? http://clsbluesky.law.columbia.edu/2013/11/15/why-have-nohigh-level-executives-been-prosecuted-in-connection-with-the-financial-crisis/ 9 212 U.S. 481 (1909).
10 Id. at 494-95.
prosecution of business entities did not particularly flourish. According to one estimate, through the 1980s fewer than one percent of federal criminal prosecutions were brought against business entities. 11 Nor did New York Central provide much guidance with respect to when business entities should be prosecuted.
Since New York Central, federal courts have generally adopted a broad, respondeat superior approach to business entity criminal liability. Thus, a business entity is liable for the acts of its employees when they act within the scope of their employment, and with the intent of benefiting the entity, and not exclusively themselves. 12 “[T]he corporation may be criminally bound by the acts of subordinate, even menial, employees.”13 In United States v. Basic Construction Co., 14 for example, the Court of Appeals affirmed a conviction for bid-rigging, rejecting the corporation’s argument that the offense was carried out by “minor officials” without the knowledge of management and against established company policy. In United States v. Harry L. Young & Sons, Inc., 15 the company was held criminally liable when two drivers left a truck full of explosives unattended, in violation of company policy and dispatcher instructions. In the words of one court, “the only thing that keeps deceived corporations from being indicted for the acts of their employee-deceivers is not some fixed rule of law or logic but simply the sound exercise of prosecutorial discretion.” 16 11 Robert S. Patterson, Sr., Organizational Sentencing Guidelines, 29 Tenn. B.J. 28, 28 (Jan.-Feb. 1993).
12 See, e.g., United States v. Jorgensen, 144 F.3d 550, 560 (8th Cir. 1998); Third Circuit Manual of Model Jury Instructions – Criminal 7.06.
13 Standard Oil Co. of Tex. v. United States, 307 F.2d 120, 127 (5th Cir. 1962).
14 711 F.2d 570 (4th Cir. 1983).
15 464 F.2d 1295 (10th Cir. 1972).
16 United States v. Sun-Diamond Growers of California, 138 F.3d 961, 970 (D.C. Cir. 1998), aff'd, 526 U.S. 398 (1999).
adoption of the Organizational Sentencing Guidelines of the United States (“Sentencing Guidelines”). 17 Formerly mandatory and now advisory, 18 the Sentencing Guidelines rested on two principles: the business entity should “remedy any harm caused by the offense,” and its punishment “should be based on the seriousness of the offense and the culpability of the organization.” Culpability, in turn, was determined by six factors: the business entity’s “involvement in or tolerance of criminal activity”; its “prior history”; any “violation of an order”;
“obstruction of justice”; “the existence of an effective compliance and ethics program”; and “self-reporting, cooperation, or acceptance of responsibility.” 19 The Sentencing Guidelines concern post-conviction sentencing, but the standards set forth therein are obviously relevant to charging decisions and the exercise of prosecutorial discretion.
The first formal statement of principles in charging business entities came from then-Deputy Attorney General Eric H. Holder, Jr. in June 1999. 20 Known as the Holder Memorandum, it adopted the basic rules of respondeat superior as governing criminal prosecutions: “Under the doctrine of respondeat superior, a corporation may be held criminally liable for the illegal acts of its directors, officers, employees, and agents. To be held liable for these actions, the government must establish that the corporate agent's actions (i) were within the scope of his duties and (ii) were intended, at least in part, to benefit the corporation. In all cases involving wrongdoing by corporate agents, prosecutors should consider the corporation, as well as the responsible individuals, as potential criminal targets.” 17 Now at United States Sentencing Guidelines (“U.S.S.G.”) Manual § 8C 2.1-2.9.
18 In United States v. Booker, 543 U.S. 220 (2005), the Supreme Court held that the Sentencing Guidelines, passed by congress as mandatory requirements for sentencing, were unconstitutional. The Sentencing Guidelines are now considered advisory.
19 U.S.S.G. Manual ch. 8 “Introductory Commentary.” 20 Memorandum from Deputy Attorney General Eric H. Holder, Jr. to Heads of Department Components and U.S.
Attorneys, Bringing Criminal Charges Against Corporations (June 16, 1999).
Department of Justice in deciding whether it would exercise its discretion to indict (or refrain from indicting) a business entity. The Holder Memorandum identified eight factors that prosecutors should consider in determining whether to charge a business entity: “the nature and seriousness of the offense,” “the pervasiveness of wrongdoing within the corporation,” “the corporation's history of similar conduct,” “timely and voluntary disclosure of wrongdoing and its willingness to cooperate in the investigation of its agents, including, if necessary, the waiver of the corporate attorney-client and work product privileges,” “the corporation's compliance program,” “remedial actions,” “collateral consequences,” and “the adequacy of non-criminal remedies.” The Holder Memorandum was revised several times, but all revisions retained the basic respondeat superior premise for corporate prosecutions.
The accounting scandals at Enron Corporation, Worldcom and several other companies brought a renewed focus on the financial services industry. In March 2002, the DOJ indicted accounting giant Arthur Andersen, which was the outside auditor for Enron Corporation.
Although the indictment was limited to a charge of obstruction of justice (shredding of documents by its employees at the directions of a supervising partner and an in-house counsel), Arthur Anderson effectively went out of business shortly after its conviction in June
2002. The conviction was later vacated by the Supreme Court, 21 but the damage to Arthur Anderson’s business was done.
These events seemingly caused the DOJ to focus greater effort on the prosecution of individuals, but also to use increasingly aggressive investigative techniques (such as demanding waiver of the attorney-client privilege) against business entities. In 2003 the new 21 Arthur Andersen LLP v. United States, 544 U.S. 696 (2005). The government chose not to retry the case.
be considered in determining whether they seek an indictment against a business entity – “adequacy of prosecution of individuals.” The Thompson Memorandum also elaborated on the effect of a failure to cooperate with the government. This latter factor, especially insofar as it
The DOJ also began to resort more frequently to deferred prosecution agreements, a less harsh form of criminal sanction than a guilty plea. The Thompson Memorandum included a reference to deferred prosecution agreements, and noted that corporate cooperation could lead to granting a business entity not only “immunity or amnesty,” as in the Holder Memorandum, but also “pretrial diversion.” 24 The business entity guidelines were revised again in 2008, 25 and today are reflected into the U.S. Attorneys’ Manual. 26 The Manual incorporates the factors set out in the Holder and
22 Memorandum from Deputy Attorney General Larry Thompson to Heads of Department Components and U.S.
Attorneys, Principles of Federal Prosecution of Business Organizations (Jan. 20, 2003).
23 The government’s aggressive tactics inspired extensive commentary and resulted in the dismissal of the indictment in United States v. Stein, 541 F.3d 130 (2d Cir. 2008). In Stein, the Court of Appeals affirmed dismissal of an indictment against partners and employees of the accounting firm KPMG, LLP, because government pressure on the company to halt payment of attorneys fees for targeted employees interfered with their ability to retain counsel. The standards of the Thompson Memorandum in this respect were substantially modified by yet another set of guidelines, issued by then-Deputy Attorney General Paul J. McNulty. Memorandum from Deputy Attorney General Paul J. McNulty to Heads of Department Components and U.S. Attorneys, Principles of Federal Prosecution of Business Organizations (Dec. 12, 2006) (the “McNulty Memorandum”).