Elsen comments on articles by Deborah DeMott and James Cox. He agrees with them that the rules governing conduct are often different from the rules written in compliance programs and as part of codes of conduct

Elsen, Sheldon H.

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ELSEN.FMT 09/16/98 4:20 PMCOMMENTARYSHELDON H. ELSEN*As a trial lawyer with practical experience in the area of corporate miscon-duct, I have had the opportunity to deal firsthand with the rules governing con-duct in various corporations.  Based upon my experience representing corpora-tions and corporate executives, I agree with Professors Deborah A. DeMott1and James D. Cox2 that the rules actually governing conduct are often differentfrom those written in compliance programs and codes of conduct.  However,while Professor DeMott refers to these unwritten rules as incentives to breakthe law, my experience leads me instead to characterize them as pressures tobreak the law.  I believe this difference in language carries with it a differentappraisal of the resulting misconduct, and a somewhat different sense of whatto do about it.  Specifically, I can think of two situations I have experiencedthat lead me to this characterization.The first situation involved foreign bribery investigations.  In response tothe SEC’s campaign to require public companies to disclose foreign bribery, Iwas retained by a Fortune 100 company that had food operations all over theworld.  I still vividly remember arriving in a third world country and meetingwith the company’s middle management.  They were in despair because thecompany was now looking critically at activities they believed senior manage-ment knew about and condoned.  For example, in an effort to get a license fromthe local authorities for a three-inch water pipe into the plant, a plant managerwith the company let a local on his staff bribe the authorities, because theauthorities were insisting they would permit only a one-inch pipe.  The plantmanager and everyone at the plant knew bribery had to be used.  Thus, whenthe plant manager learned that the head of the company’s international divisionand senior management had denied any knowledge of these activities, hescoffed and rather bitterly said that he himself had no wish to engage in thesetypes of activities—he taught Sunday school and was trying to bring up his chil-dren according to an American middle-class value system.  Everyone knewwhat had to be done to do business in that country, yet he was being saddledwith the blame.No criminal or civil cases grew out of this or most foreign bribery investiga-tions, but the result was that many middle managers, like the plant manager I                                                          Copyright © 1997 by Law and Contemporary ProblemsThis article is also available at http://www.law.duke.edu/journals/lcp.* Senior Partner in the law firm of Orans, Elsen & Lupert and Adjunct Professor of Law, Co-lumbia University.1. See Deborah A. DeMott, Organizational Incentives to Care About the Law, 60 LAW &CONTEMP. PROBS. 39 (Autumn 1997).2. See James D. Cox, Private Litigation and the Deterrence of Corporate Misconduct, 60 LAW &CONTEMP. PROBS. 1 (Autumn 1997).ELSEN.FMT 09/16/98  4:20 PM88 LAW AND CONTEMPORARY PROBLEMS [Vol. 60: No. 4had met, lost their jobs, while senior management adopted a holy code of ethicsand avoided dismissal.  Yet those middle managers were not rogues, and ifthere was to be responsibility, it should have been assumed by the entity andvicariously by the people at the top.The second situation I experienced that leads me to characterize unwrittencorporate rules as pressures to break the law rather than incentives involved aninvestigation of a major broker-dealer that had offices throughout the UnitedStates.  In that case, branch managers and regional administrators with a re-sponsibility to supervise major producers who were stepping over the linefound themselves stymied when they tried to bring their concerns up the ladderto senior management.  There was an unwritten rule in the company that thebig producers were to be looked after.  As a result, middle management wasleft to deal with the consequences of overstepping by big producers.  While theresulting case was notorious, senior management essentially escaped un-harmed, but the middle managers had to file Wells submissions and may wellhave become the subject of SEC disciplinary proceedings had not the Johnson3case intervened to bar such cases through the statute of limitations.Accordingly, based on these experiences, I am inclined to agree with Pro-fessors DeMott and Cox that entity liability or vicarious liability is an appropri-ate response to unacceptable behavior arising from the corporation’s businessactivities.  In addition, I think that senior management should have responsi-bility thrust on it vicariously, and there should be more compassion for themiddle managers who are forced either to carry out the company’s wishes orrisk losing their jobs.However, I have greater reservations with regard to personal liability for di-rectors.  As Chancellor Allen persuasively argues, too tough an enforcement ofthe duty of care could make it hard for corporations to attract outside direc-tors.4  In response to this possible problem, Professor DeMott attempts to finda reasonable halfway point by which directors can be held accountable whensenior management itself has become involved in wrongdoing.  She suggestsdrawing on the standards for entity liability as set forth in the Federal Sen-tencing Guidelines for Organizations,5 which decree that a corporation lacks aneffective compliance program when senior management or certain supervisingemployees are complicit in wrongdoing.6  However, for the reasons I havegiven, it is sometimes hard to say when senior management has been complicit.Here, as elsewhere, the Sentencing Guidelines are not always wise or accurate.It does not seem unreasonable to say, as Professor DeMott does, that the direc-tors should have the burden of demonstrating their good faith in a situation                                                          3. See Johnson v. SEC, 87 F.3d 484, 492 (D.C. Cir. 1996) (applying the five-year statute of limita-tions of 28 U.S.C. § 2462 to an SEC proceeding seeking censure and suspension of a securities supervi-sor under § 15(b) of the Securities Exchange Act of 1934).4. William T. Allen, Address at the Duke University School of Law/Institute for Law and Eco-nomic Policy’s Conference on Deterring Corporate Misconduct (Nov. 15, 1997).5. See DeMott, supra note 1, at 63-64.6. See U.S. SENTENCING GUIDELINES MANUAL § 8C2.5(f) (1997).ELSEN.FMT 09/16/98  4:20 PMPage 87: Autumn 1997] ELSEN COMMENTARY 89where senior management has been complicit in wrongdoing.7  But the questionof proving such complicity may be a thorny one.When there has been a criminal investigation, as in the Caremark8 case aswell as actions involving Salomon Brothers9 and Prudential Securities,10 thecompany comes under pressure from law enforcement to give up its senior offi-cials in order to save the company.  In Caremark, the company did not takesuch action, but in the Salomon Brothers proceeding, the top people were sur-rendered in order to save the company.Putting the finger on senior management may thus happen fortuitously.  Ifthe directors of a corporation that has been the subject of criminal investigationare to be more exposed to personal liability than the directors of a corporationwhere there has been wrongdoing but no criminal investigation, similar casesmay not be treated alike.  Plaintiffs would have an easier time pleading andproving the misdeeds of senior management where there has been an investiga-tion, particularly where senior management has admitted complicity as inSalomon Brothers, but plaintiffs might have to put in a substantial case toprove complicity of senior management when there has been no criminal inves-tigation.The result may be that, if the shift of the presumption were considered im-portant, the parties might have to engage in a sideshow at trial over the com-plicity of senior management, rather than focus on evidence about the direc-tors.  This might not be so if senior management were co-defendants, but that isnot always the case.Perhaps more importantly, I have some question about how much differ-ence shifting the presumption would make in a case where the directors couldmeet their burden of showing good faith simply through their testimony, thusleaving it for the plaintiff to prove an absence of good faith from the circum-stantial evidence, much as the plaintiff has to today.Thus, the result of Professor DeMott’s innovation might be a scattering ofresults, a possible increase in the cost of litigation, and a sense that similar casesare not being treated alike.  While I agree with Professor DeMott that directorsshould be held accountable if they wink at a situation in which senior manage-ment has created a culture that invites wrongdoing, I believe her concept re-quires refining.As to Professor Cox’s article, I am generally in agreement.  However, I doquestion his conclusion that the class action has fallen out of favor.  He bases                                                          7. See DeMott, supra note 1, at 63-65.8. See In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996) (holding that aboard of directors has an affirmative duty to ensure the appropriate supervision of the corporation’semployees and agents).9. In this action, the Chief Executive and General Counsel of Salomon Brothers were administra-tively disciplined for failure to supervise misconduct on lower levels within the firm.10. See generally KURT EICHENWALD, SERPENT ON THE ROCK (1995).ELSEN.FMT 09/16/98  4:20 PM90 LAW AND CONTEMPORARY PROBLEMS [Vol. 60: No. 4this conclusion on the opinions of conservative Justices in Blue Chip Stamps11and Central Bank,12 and the 1995 Private Securities Litigation Reform Act.13However, there are still Supreme Court Justices as well as many lower courtjudges who view the class action as the Supreme Court did in Borak.14  Fur-thermore, I can say from my own involvement in the congressional debates sur-rounding the 1995 Reform Act that despite the changes there remained a con-sensus among the members of Congress that the class action should bepreserved.  During the debates, critics of the class action had introducedharsher provisions that would have effectively killed class actions.  Specifically,critics introduced provisions to require “loser pays,”15 the destruction of thefraud on the market theory, and pleading requirements for scienter that wouldhave been impossible for plaintiffs to meet. 16  But these provisions were essen-tially all removed by what I like to think of as the informed majority of theSenate.  While the bill that passed could indeed be characterized as critical ofwhat Congress considered excesses in class action practice, a majority of Con-gress as well as the President all acted on the basic premise that the class actionplays a useful role and should be preserved. 17I am also in agreement with Professor Cox’s criticism of the law and eco-nomics analysis of Professor Arlen and others.18  I add only that I think he hasbeen too kind.  Professor Arlen’s analysis starts from the premise that corpo-rate conduct is based on a calculus of what will make the most money.19  Butwhen corporate officers are considering what to do, they normally cannot makethose kinds of dollars and cents calculations.  Professor Arlen’s hypothesis thatabandonment of compliance programs will ultimately save the corporationmoney strikes me as rather naive.  Indeed, the consequences of wrongdoingmay not only be civil; they may be criminal as well.  Wrongdoing may or maynot be covered by insurance.  In addition, if a scandal erupted in the newspa-pers, management could be turned out.  Thus, a compliance program is gener-                                                          11. See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975) (finding that standing tobring a private damages suit under Rule 10b-5 is limited to actual “purchasers” or “sellers” of securi-ties as defined in the Securities Exchange Act of 1934).12. See Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994) (holdingthat a private plaintiff may not bring an aiding and abetting suit under § 10(b), the general antifraudprovision of the Securities Exchange Act of 1934).13. Pub. L. No. 104-67, 109 Stat. 737.14. See J.I. Case Co. v. Borak, 377 U.S. 426 (1964) (holding that the Securities Exchange Act of1934 authorizes a federal cause of action for rescission or damages to a corporation’s shareholder inthe context of a merger transaction completed pursuant to a false and misleading proxy statement).15. The “loser pays” provision intended to make the losing side pay the attorneys’ fees for theprevailing party.16. In earlier versions of the bill, the plaintiff would have been required to plead the defendant’sstate of mind during each violation, without having had the benefit of discovery.17. See generally Securities Litigation Reform Proposals: Hearings on H.R. 1058 Before the Sub-comm. on Securities of the Senate Comm. on Banking, Housing, and Urban Affairs, 104th Cong. 131(1995) (statement of Sheldon H. Elsen, Association of the Bar of the City of New York).18. See Cox, supra note 2, at 11-20.19. See Jennifer Arlen, The Potentially Perverse Effects of Corporate Criminal Liability, 23 J.LEGAL STUD. 833 (1994).ELSEN.FMT 09/16/98  4:20 PMPage 87: Autumn 1997] ELSEN COMMENTARY 91ally essential for protection.  While law and economics may have applicationsin some areas of the law, applied here it seems out of touch with the realities ofcorporate decisionmaking.

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