Governance and Compliance Update
 
July 7, 2005
 

“Ex-Directors At WorldCom Settle Anew. A landmark agreement by former WorldCom directors to pay millions of their own money to settle with investors was revived yesterday about six weeks after it was scuttled by objections from other defendants in the case.” The New York Times, March 19, 2005

“Morgan Stanley Already Feeling Wounds of War. Also yesterday, in a reminder of the firm’s persistent regulatory woes, Morgan Stanley said that the Securities and Exchange Commission was investigating its e-mail retention policies. (In 2002, regulators fine the firm $1.65 million for failing to preserve e-mail messages.)” The New York Times, April 17, 2005

“Lockheed Martin Scuttles Titan Acquisition. Lockheed Martin Corp. abandoned its $2.2 billion deal to acquire Titan Corp. yesterday after the San Diego-based company failed to resolve a federal bribery investigation …” The Washington Post, June 27, 2004

“The Federal Reserve barred Citigroup, Inc. from major acquisitions until the company fixes regulatory problems that have gotten the financial-services giant in trouble around the world ...” The Wall Street Journal, October 26, 2004

“Riggs Directors Silent As Scandal Unfolded. [E]fforts by independent directors to make sure the company was complying with anti-money laundering rules were cursory at best ... “ The Washington Post, January 17, 2005

“Walt Disney Co. … has voluntarily agreed to a series of compensation-related changes designed to make management and the board more accountable to shareholders and to align their interests with investors.” Compliance Week, March 2005

“SEC Files Settled Regulation FD Charges Against Flowserve Corporation, Its Chief Executive Officer, and Director of Investor Relations. This is the first Regulation FD case filed by the Commission involving a reaffirmation of earnings by an issuer and the first settled enforcement action against a Director of Investor Relations for violating this rule.” In addition, the SEC cited the lack of cooperation by the CEO and the Director of Investor Relations in the agency’s investigation. SEC Press Release, March 24, 2005

“Corporate fraud squad marches on.” The two-and-one-half-year-old Department of Justice Corporate Fraud Task Force “has increased the number of prosecutors assigned to corporate fraud cases by an ‘astronomical’ amount. … The government has also obtained more than 500 convictions or guilty pleas against corporate executives.” Timothy Coleman, Department of Justice, National Law Journal, January 3, 2005

Why Effective Corporate Compliance and Ethics Programs Are Important

These recent reports in national media are only a small percentage of the negative reports concerning governance and compliance failures at major U.S. companies in the past few months. The scandals that generated these reports have resulted in hundreds of millions of dollars of fines, penalties and investigation costs, lengthy jail terms for executives, failed acquisitions, damage to corporate and individual reputations, bankruptcies and billions of dollars in lost value to shareholders. This first edition of Holland & Knight’s Governance and Compliance Update focuses on why both public and private companies should consider implementing or reexamining and, as necessary, updating effective corporate compliance and ethics programs. Future issues will focus on providing corporate executives and board members with best practices and proven strategies to help their companies avoid the problems associated with these kinds of headlines.

The meltdowns at Enron, Tyco, Adelphia, WorldCom and many others have produced an explosion of legal and regulatory responses the likes of which corporate America has not seen since the Great Depression. The Sarbanes-Oxley Act of 2002 (SOX) and the related SEC and NYSE/AMEX/Nasdaq rules are probably the best known in corporate offices and boardrooms. In addition, however, a series of other legal and regulatory activities, have combined to virtually mandate that management and boards of directors of both public and private corporations update and/or implement comprehensive and effective corporate compliance and ethics programs. A comprehensive compliance and ethics program is the most cost-effective means to:

• establish a corporate culture of integrity and fair dealing

• help personnel at all levels of the organization understand their compliance and ethical obligations

• provide a well-understood process for identifying and addressing compliance and ethics problems before they fester and before they are reported to law enforcement authorities

Compliance and ethics programs are not a panacea. They require frequent communication and a sustained commitment. In the long run, however, the cost and effort involved are a drop in the bucket compared to the massive cost of a significant compliance failure.

What Constitutes an Effective Program?

There exists today a convergence of requirements that go beyond the formal adoption of codes of ethics, codes of business conduct, disclosure controls and internal controls that are required under SOX. While these are an integral part of sound corporate governance and an effective compliance and ethics program, they are only part of what should be done. Companies today, whether public or private, must consider the broader aspects of effective compliance programs and sound corporate governance as a result of recent guidance from the Federal Sentencing Commission and from the Department of Justice to name the two most prominent sources.

The Sentencing Commission has recently issued a detailed update on its guidance concerning the elements of an “effective” compliance and ethics program. This guidance has become the standard by which most corporate compliance and ethics programs have been designed and operated. In addition, the Department of Justice has adopted a formal policy requiring all federal prosecutors to take into account whether or not a company has an effective compliance and ethics program in making the decision whether or not to charge a company with a criminal violation. The standard that prosecutors will use will be based on the guidance from the Sentencing Commission.

Compliance and ethics programs need to consider and integrate diverse aspects of a company’s business, legal and regulatory environment that go beyond the areas covered by the Sarbanes-Oxley Act. In today’s environment, we believe that all areas of significant potential risk and exposure need to be considered and analyzed. These risks and exposures range from the more obvious areas of Foreign Corrupt Practices Act and anti-money laundering (USA PATRIOT Act) compliance to the equally important areas relating to risks created by anti-discrimination laws, such as sexual harassment, race and age discrimination; occupational health and safety laws; environmental and anti-trust law compliance; and federal, state and local governmental procurement practices. In addition, companies in regulated industries, whether it be health care, transportation, defense or some other industry, need to consider how and whether their internal compliance practices and procedures dovetail with the applicable regulatory framework.

Directors and Officers Now Have Increased Responsibility

Recent developments in Delaware corporate law, in conjunction with the Sentencing Commission guidelines, have placed greater emphasis on director and officer involvement and oversight. Under these cases, including the landmark Delaware Chancery Court decision in In re Caremark International Inc., courts have held that directors cannot merely rely on the good faith of corporate employees, but could be held liable for failing to ensure that appropriate information and reporting systems were in place at the company. The courts further suggest that directors and officers have an affirmative duty to ensure that a corporate compliance system exists and that the absence of such a system may render directors liable for any losses caused by non-compliance with legal rules and regulations.

The importance of compliance programs in today’s business environment is also underscored by statements by prominent legal jurists and writers and in commentaries to the American Law Institute’s Principles of Corporate Governance (ALI’s Principles) and the American Bar Association’s Model Business Corporation Act. The ALI’s Principles, in addressing a director’s duty of care, recognize that compliance programs “represent a basic mechanism to assist the board in properly fulfilling its oversight role.” Similarly, the ABA’s Corporate Directors’ Guidebook recommends that directors “should assess whether the corporation has established and implemented ... appropriate policies designed to provide reasonable assurance of compliance with applicable laws and regulations.”¹

Finally, the convergence of these legal, regulatory and case law developments should not only cause a corporation to focus on the risks attendant to its operations but also the protections that need to be implemented in areas such as director and officer liability insurance and charter and/or by-law indemnification. Developments in D&O insurance and exclusions mandate that corporations re-examine the extent and scope of their coverage, not just the cost of their annual coverage.

Being Proactive Is Cost Effective

Public and private companies should consider bringing their compliance and ethics functions under a comprehensive umbrella program with related procedures and documentation. The implementation of such an umbrella program must also recognize the importance of, and integrate, in-house attorney up-the-ladder reporting and responsibilities, and coordination with an organization’s outside counsel. As the recent corporate scandals graphically demonstrate, failures in compliance can disrupt an organization’s business operations, harm reputations and adversely affect market value, not to mention the potential for massive fines, prison terms for involved executives, liability for members of the board of directors and other problems. Merely responding to an investigation into potential violations can be costly, even if the government ultimately does not take action against the organization. Sound corporate governance principles, including an effective compliance and ethics program, are the most cost-effective actions an organization can take to avoid these problems and to help shield its directors and officers from potential liability. While having such a program is not a guarantee that statutes and regulations will not be violated, a well-run program will help an organization detect or prevent wrongdoing at an early stage, provide an opportunity to correct the problem before the government becomes involved, and, in most instances, a truly effective program will help organizations avoid prosecution altogether.

This Governance and Compliance Update is a summary for general information and discussion only. It is not a complete analysis of the matters presented and may not be relied upon as legal advice which may often turn on specific facts. Readers should seek legal advice before acting with regard to the matters mentioned herein.

For more information, contact any of the following Holland & Knight professionals or call toll free, 1-888-688-8500.

Midwest:

Jonathan E. Strouse 312 715 5741 jonathan.strouse@hklaw.com

West Coast:

Richard Thomas Williams 213 896 2410 richard.williams@hklaw.com

Mark A. von Bergen 503 243 5874 mark.vonbergen@hklaw.com

Southeast:

Gregory Baldwin 305 789 7745 gregory.baldwin@hklaw.com

Harvey Goldman 305 789 7506 harvey.goldman@hklaw.com

James D. Wing 305 789 7768 james.wing@hklaw.com

Northeast:

James M. Lurie 212 513 3354 james.lurie@hklaw.com

Mid-Atlantic:

Christopher Myers 703 720 8038 chris.myers@hklaw.com

Michael Mannix 703 720 8024 michael.mannix@hklaw.com

¹ The importance of the board’s involvement in insuring that an effective compliance and ethics structure exists is brought home by the recent settlement negotiations in the MCI and Enron shareholder actions, in which members of the boards of directors are being asked to contribute millions of dollars of their personal assets toward the settlements, in addition to the amounts available through Director and Officer liability insurance policies.