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Deferred Prosecution Deals Create Harmful Incentives
December 18, 2006; Page A17
Wall Street Journal

My Nov. 28 editorial-page commentary "The Deferred Prosecution Racket" brought forth a spirited but wholly unconvincing response by Patrick E. Hobbs, dean of the Seton Hall Law School ("Fighting the Infection of Unethical Behavior in Corporate Culture," Letters to the Editor, Dec. 8). Dean Hobbs defends his law school's decision to accept money for a business ethics program pursuant to the deferred prosecution agreement between the U.S. Attorney for New Jersey, Christopher J. Christie, and Bristol-Myers Squibb. It is sheer naivetÚ to assume that BMS and its attorneys signed on, as Dean Hobbs suggests, because of their deep belief that "the wrong corporate culture can become a breeding ground for unethical and criminal behavior." There's no way that BMS would have made that donation if freed from the risk of corporate prosecution. To avoid the taint, let Dean Hobbs raise money for a worthy project from one of thousands of New Jersey firms not faced with the threat of federal indictment.

If anything, his defense of the BMS-Seton Hall gift shows just how cancerous DPAs can be. Any good course in business ethics would stress the dangerous institutional incentives put in play if DPAs can direct payments to public charities. Let's posit that Seton Hall did nothing whatsoever to urge Mr. Christie to funnel money to it through the DPA. No matter: Once this precedent is set, it's open season for every public institution to lobby prosecutors for a piece of the action. Worse still, nothing prevents these organizations from quietly supporting criminal investigations to increase the likelihood of such windfalls. The public should not tolerate any arrangements that introduce these third-party influences into the prosecutor's office. Any excellence of Mr. Christie as a prosecutor or of Seton Hall in ethics reform are tainted by this gift, which the law school should return forthwith.

The systemic problems with DPAs, unfortunately, cannot be solved by Timothy Coleman's proposal (Letter, Dec. 8) to incorporate the various mitigating elements of DPA into the underlying criminal case. That approach will only clog criminal trials with matters wholly irrelevant to guilt or innocence. And it will fail to soften the present dire consequences from the threat of prosecution. Similarly, it is unwise (and futile) to seek congressional legislation to eliminate the harsh collateral consequences of a federal indictment in other federal agencies. Even if enacted, that legislation would not keep state regulators from pulling their licenses. The downward spiral of DPAs must be stopped at its source, by insulating corporations (but not their senior officers) from criminal prosecution. The recent McNulty memorandum doesn't shred the Thompson memorandum. But at least it is a start.

Richard A. Epstein
Professor of Law
University of Chicago
Senior Fellow
Hoover Institution
Chicago

Fighting the Infection of Unethical Behavior in Corporate Culture
December 8, 2006; Page A17
WSJournal

In his Nov. 28 editorial-page commentary "The Deferred Prosecution Racket," Richard A. Epstein writes that often a prosecutor's "only credible threat against a recalcitrant corporation is the criminal indictment -- yet simply filing an indictment triggers huge collateral repercussions sufficient to drive the firm out of business, as teams of state and federal regulators are now duty-bound to suspend the licenses and permits under which the corporation does business." And yet when prosecutors work to avoid such outcomes by entering into a deferred prosecution agreement (DPAs), he describes them as Stalinist actors delivering punishments "wildly in excess of any underlying offense." His poster boy for abusing this Soviet-style tactic is the U.S. attorney for New Jersey, Christopher J. Christie. His most egregious example is the DPA entered into with Bristol-Myers Squibb (BMS), and, in particular, paragraph 20 requiring BMS to endow a chair at Seton Hall University School of Law.

Mr. Christie has been aggressive in fighting public corruption. In the corporate context, he has proceeded with caution, intent on curbing abuses but mindful of the interests of shareholders and employees. He recently settled Medicaid fraud and abuse claims against one of the state's largest health-care systems in a manner that ensured the return of federal dollars and the implementation of systems to prevent future abuse, but importantly, ensured the continuation of quality health care for thousands of New Jerseyans, as well as 5,000 jobs. This hardly suggests someone wielding his power in an abusive manner.

So what about that provision that Bristol-Myers Squibb endow a chair at Seton Hall Law School, Mr. Christie's alma mater? Is that really abusive? At Seton Hall, we believe that had Prof. Epstein investigated more closely he would have paused before declaring that this is the "most striking evidence of the abuse of power." Recent scandals make it clear that far too many corporations have lost their ethical compass. Prof. Epstein would argue that only humans are capable of such a thing. I disagree. The wrong corporate culture can become a breeding ground for unethical, and criminal behavior. Mr. Christie recognized, and BMS and its attorneys agreed, that in order to ensure that such problems would not arise again, an academic partner should be found that could engage the executive leadership of BMS in discussions of best practices and that could offer scholarship examining the difficult and ever-evolving ethical dilemmas of the corporate world.

Neither Mr. Christie nor BMS had far to look, and Seton Hall Law School would have been the natural choice for any U.S. attorney. Our health law program has been ranked in the top five nationally by U.S. News & World Report for almost 10 years. For the past four years we have focused on legal and ethical issues for pharmaceutical executives through our highly regarded corporate compliance program, with more than 300 executives from more than 50 companies and eight countries completing the certification. Our faculty have been leaders in promoting ethics reform in government. For instance, Newark Mayor Cory Booker enlisted the assistance of Prof. Paula Franzese to write that city's ethics code and I serve as a commissioner on the State Commission of Investigation, charged with rooting out corruption in state government. BMS's former general counsel, John McGoldrick, and BMS's lead outside attorney and former U.S. attorney for the Southern District of New York, Mary Jo White, were well versed in Seton Hall's leadership in health law, corporate compliance, and business ethics.

The important work that will be enabled by the BMS endowment will enable Seton Hall to expand its already robust programming in the corporate compliance and business ethics areas.

Patrick E. Hobbs
Dean and Professor of Law
Seton Hall University School of Law
Newark, N.J.

Prof. Epstein illustrates how overly broad legal standards for corporate criminal liability have led to the trend toward deferred prosecution agreements. However, his suggestions for containing the "nuclear option" of corporate prosecution are impractical and unlikely to be adopted. The probability that a Democratic Congress will "repeal by statute the doctrines of vicarious liability for criminal conduct in a corporate context" is somewhat lower than the chance that Enron will emerge from bankruptcy and rocket back to the top of the Fortune 500. And a Republican administration that has largely blunted claims of business cronyism by aggressively prosecuting major corporations is not about to disavow "the odious Thompson memo" that facilitated that strategy so successfully.

A more effective, and politically possible, reform would be for Congress to transfer the discretion to hold corporations criminally liable from the prosecutors to the courts, and to restrict the government's ability to threaten companies with fatal collateral consequences based merely on an indictment. For example, Congress could pass legislation that conditions corporate criminal liability on proof at trial of some of the very factors articulated in the Thompson memo, such as senior management's participation in the offense conduct and the failure to implement an effective corporate compliance program. Congress could also restrict the power of regulatory agencies such as the SEC, the Department of Health and Human Services and the Defense Department to "drive the firm out of business" prior to conviction by "suspending the licenses and permits under which the corporation does business." If the government were required to prove the so-called Thompson memo factors beyond a reasonable doubt at trial, it would be less likely to threaten to indict a corporation in the first place. And if the government could not threaten to put the company out of business by merely filing an indictment, it would have far less leverage to force corporations to enter into deferred prosecution agreements.

Timothy J. Coleman
Washington
(Mr. Coleman is partner and co-chair,White Collar Crime and Government Investigations Practice Group, Dewey Ballantine.)

The Deferred Prosecution Racket

By RICHARD A. EPSTEIN
November 28, 2006; Page A14
WS Journal

Corporations suffer a peculiar vulnerability. The rules of criminal liability allow federal and state prosecutors to unduly punish those corporations that fall within their crosshairs. But the recent emergence of deferred prosecution agreements (DPAs) to force major changes in corporate governance should give pause to even the most ardent populist.

A DPA is a provisional settlement of a criminal lawsuit whereby the prosecutor agrees to suspend -- but not to dismiss -- any prosecution in exchange for the corporation's promise to reform its internal operations in specified ways. A sensible settlement can split the difference, by having a defendant pay half the maximum fine or sentence. But with corporations they take on an entirely different -- and sinister -- complexion.

* * *

The last thing a corporation fears (since it cannot be imprisoned) is the maximum fine from a successful criminal conviction. Rather, the deadly force of the DPA rests in a combination of two key factors: vicarious corporate criminal liability, and the collateral consequences of the initial indictment prior to, and independent of, any eventual conviction.

[The Deferred Prosecution Racket]

Vicarious liability, as first developed in tort law, allows innocent third parties to sue not only an individual wrongdoer for damages, but also his employer, so long as the wrongdoer's act is within the scope of his employment. In the context of tort law, this rule ensures funds for compensating innocent victims, while giving a firm the incentive to monitor its employees. Many judicial decisions have, however, unwisely imported this doctrine wholesale into the criminal arena -- allowing a corporation to be punished criminally for the actions of any midlevel or senior employee, even if the corporation neither authorized nor condoned the wrongful action.

Writing in January 2003, Larry Thompson, then deputy U.S. attorney general, exhorted federal prosecutors to use vicarious liability to extract favorable settlements to reform corporate defendants from the outside. The Thompson memorandum insisted that corporations receive a temporary reprieve only if they purge themselves of individual wrongdoers and agree to extensive government oversight to make them walk the straight and narrow path.

In pursuing Mr. Thompson's strategy, prosecutors face both a dilemma and an opportunity. Their only credible threat against a recalcitrant corporation is the criminal indictment -- yet simply filing an indictment triggers huge collateral repercussions sufficient to drive the firm out of business, as teams of state and federal regulators are now duty-bound to suspend the licenses and permits under which the corporation does business. Thus, the corporation that has strong protections against false convictions -- proof beyond a reasonable doubt of the elements of the crime, the ability to examine evidence or cross-examine witnesses -- is helpless to protect itself. A conviction carries at most a million-dollar fine, but simple indictment, which lies wholly within the prosecutor's discretion, imposes multibillion-dollar losses.

Faced with that kind of pressure, the indictment is all that matters. Yet given these weird incentives, DPAs no longer serve the public interest. The agreements often read like the confessions of a Stalinist purge trial, as battered corporations recant their past sins and submit to punishments wildly in excess of any underlying offense.

Evidence of the gravity of the situation is only a mouse-click away. In one such notable agreement, the U.S. attorney for New Jersey, Christopher J. Christie, put the screws to Bristol-Myers Squibb, which got into hot water because of a potential securities violation for inflating its quarterly earnings by a business practice known as channel stuffing. BMS told its distributors that they had to take into inventory large amounts of BMS products immediately, with the understanding that down the road they could return the excess for a refund. The alleged securities violation arises from the overstated earnings quarterly reports, without indication of any expected future write-offs.

The na´ve reader might think that a DPA should prohibit the firm from engaging in future conduct of the sort that got it into hot water in the first place. But Mr. Christie had larger ambitions. The most striking evidence of the abuse of power is paragraph 20 of the agreement, which requires BMS to "endow a chair at Seton Hall University School of Law," Mr. Christie's alma mater, for teaching business ethics, a course that he himself could stand to take.

That mild government peccadillo is a mere prelude to the sterner stuff to come. BMS agreed not only to abide by the law and to purge its ranks of the parties responsible for the scheme, but also to exhibit "exemplary corporate citizenship." To that end, all its activities have been overseen by Mr. Christie's independent adviser, former federal district court judge Frederick B. Lacey, who has the power to attend all meetings and review all documents -- and to report his findings to Mr. Christie. BMS was ordered to restructure its internal operations and appoint a new chief compliance officer to assist Mr. Lacey. It also agreed to pay a $100 million fine and make contributions of $350 million to a fund for present and former shareholders.

All these key provisions flunk the most elementary standards of business rationality -- if the object of these DPAs is to restore the confidence of shareholders in the firm. How can any firm act decisively with a government mole in its midst? What other firm would seek to acquire BMS, knowing that they must thereby give Mr. Christie the keys to its boardroom? And what purpose do shareholder funds serve, other than to impose random transfers among shareholders?

A DPA such as this one erodes the most elementary protections of the criminal law, by turning the prosecutor into judge and jury, thus undermining our principles of separation of powers. The Bristol-Myers Squibb DPA allows the prosecutor to lower the boom following the recommendation of Mr. Lacey. The corporation's sole remedy is to plead its case before the prosecutor in an environment wholly devoid of the most rudimentary procedural protections.

These powers were implemented when Mr. Christie threatened to reinstate the indictment if the board did not remove CEO Peter R. Dolan for his role in an aborted agreement with Canadian corporation Apotex. The agreement -- to delay Apotex's introduction of a generic competitor to Plavix, BMS's best-selling blood thinner -- led to a criminal antitrust investigation. Any connection between channel stuffing and price fixing remains unclear.

* * *

BMS is not the only instance of prosecutorial zeal. A New York deferred prosecution agreement with KPMG in essence required the firm to stop payment to former employees to cover the defense expenses in criminal prosecutions for tax fraud before Judge Lewis A. Kaplan in New York's southern district. Mr. Kaplan rightly treated the government's decision as an unwarranted interference with the defendants' constitutional right to the assistance of counsel and a deprivation of liberty without due process of law. He has ordered a cessation of proceedings until the defense lawyers could regroup their forces.

Yet we should do far better. For starters, the Department of Justice should engage in unilateral disarmament by disavowing the odious Thompson memo, and rethinking why it ever needs to threaten the nuclear option of a corporate indictment. For its part, our new Congress should repeal by statute the doctrines of vicarious liability for criminal conduct in a corporate context -- because these give the government unwarranted and arbitrary power over corporations.

At bottom, corporations are just individuals tied together by an elaborate network of contracts; and we don't need yet another sorry reminder of how mindless government policies harm the innocent shareholders whom they are supposed to protect. The government has a vital role in criminal enforcement. So let it go after real, i.e., human, criminals the old-fashioned way, by careful investigation and skilled prosecution.

Mr. Epstein is the James Parker Hall Distinguished Service Professor of Law at the University of Chicago and the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution at Stanford University. He is the author, most recently, of "Overdose: How Excessive Government Regulation Stifles Pharmaceutical Innovation" (Yale University Press, 2006).