More than ever before, corporate directors must take a more active role in educating themselves about the business operations of the companies on whose boards they serve. This is particularly so for those who serve on the boards of companies engaged in highly regulated industries such as health care, life sciences, and government contracts. New aggressive enforcement trends by government regulators and law enforcers make this proactive approach a necessity to protect directors from an expanding web of civil and criminal liability.
What is the risk?
The risk stems from the increasing willingness of the United States Department of Justice (DOJ) to prosecute senior officers and directors for civil and criminal violations under what is known as the Responsible Corporate Officer Doctrine (RCOD). While it has always been the case that individuals who actively and intentionally participate in criminal activity have the potential to be prosecuted for their actions, law enforcers are now delving even deeper into the boardroom to apply heavy retrospective scrutiny to board members. Their goal is to determine whether individual board members carried out their oversight responsibilities in a way that could have prevented allegedly illegal acts from occurring in the first place.
The RCOD enables prosecutors to attempt t
o hold a corporate officer or director vicariously liable for the criminal violation of a subordinate employee of the company under the following conditions (1) the officer occupies a position of responsibility and authority in the corporation, (2) has the power to prevent the violation, and (3) fails to do so. The RCOD dramatically raises the stakes for directors, in particular, who may view themselves as far removed from the every day operations of the company. Under the RCOD, senior officers and directors can be found liable for the illegal acts of other corporate agents, without proof that the officer or director directly participated in or authorized the act.
Nor is this personal risk only theoretical as recently demonstrated by the DOJ. In January 2010, the DOJ announced an unprecedented issuance of indictments and arrests of senior corporate executives from several companies who allegedly engaged in activities prohibited under the Foreign Corrupt Practices Act (FCPA). After a lengthy undercover operation spearheaded by the Federal Bureau of Investigation, the DOJ disclosed the following in its press release touting the results of its investigative efforts:
“Twenty-two executives and employees of companies in the military and law enforcement products industry have been indicted for engaging in schemes to bribe foreign government officials to obtain and retain business…The indictments stem from an FB undercover operation that focused on allegations of foreign bribery in the military and law enforcement products industry.
The 16 indictments unsealed today represent the largest single investigation and prosecution against individuals in the history of DOJ’s enforcement of the Foreign Corrupt Practices Act (FCPA), a law that prohibits U.S. persons and companies, and foreign persons and companies acting in the United States, from bribing foreign government officials for the purpose of obtaining or retaining business. The indictments unsealed today were returned on Dec. 11, 2009, by a grand jury in Washington, D.C.
In connection with these indictments, approximately 150 FBI agents executed 14 search warrants in locations across the country, including Bull Shoals, Ark.; San Francisco; Miami; Ponte Vedra Beach, Fla.; Sarasota, Fla.; St. Petersburg, Fla.; Sunrise, Fla.; University Park, Fla.; Decatur, Ga.; Stearns, Ky.; Upper Darby, Penn.; and Woodbridge, Va. Additionally, the United Kingdom’s City of London Police executed seven search warrants in connection with their own investigations into companies involved in the foreign bribery conduct that formed the basis for the indictments.”
The indicted included directors, chief executive officers, senior vice presidents, and managing partners of various companies engaged in the manufacture and sale of military and law enforcement equipment.
According to a series of public comments made by DOJ officials last fall, the DOJ is now applying RCOD theories in civil and criminal anti-fraud enforcement actions across other industries, including the medical device and pharmaceutical manufacturing industries. Given the federal government’s HEAT initiative and its strong focus on health care fraud and abuse, the DOJ, the Food and Drug Administration, and the Department of Health and Human Services Office of Inspector General may well be inclined to assert the RCOD against the officers and directors of health systems and other health care providers in circumstances involving allegations of substandard care or other False Claims Act scenarios.
The roots of the RCOD can be traced to two U.S. Supreme Court cases: U.S. v. Dotterweich (1943), and U.S. v. Park (1975). The RCOD has traditionally been applied in cases involving “public welfare” laws, e.g., food and drug, environmental and, significantly, securities laws. Indeed, both the Securities Act of 1933 and the Securities Exchange Act of 1934 provide liability on the part of a “person who controls” a violator of the securities laws. Of course, the Securities and Exchange Commission and the DOJ work closely together on matters that involve corporate fraud, such as that prohibited by the FCPA, and other securities-related violations.
The prosecutions associated with U.S. v. Norian Corp. are a prominent example of the DOJ utilizing the RCOD in the health care context. In the Norian Corp matter, four corporate officers were indicted under the RCOD based on their involvement in conducting unauthorized clinical trials of a bone cement-oriented medical device for medical indications that were not approved by the FDA also known as “Off Label.” In July, 2009 two of these executive officers pleaded guilty to a single misdemeanor charge for their involvement in these unauthorized clinical trials of medical devices. As part of their guilty pleas, the executives stipulated that they were “responsible corporate officers” at the time the disputed clinical trials occurred.
Under egregious circumstances, the DOJ may exercise its prosecutorial discretion to pursue individual directors based on their action or inaction depending on the individual director’s role, on what committee’s the director served, and attendance or lack thereof at key board meetings. In certain regulated industries, officers and directors are obligated to certify the company’s compliance with critical regulatory obligations. These certifications, of course, create a statutory “paper trail” that can lead directly back to the certifying director if it later turns out that the company was not in compliance with the necessary regulatory standards. This use of the RCOD arises at the same time that the Delaware Chancery court and other courts are experiencing an increase in litigation asserting breach of fiduciary duty causes of action against corporate officers and directors–including officers who are not board members (e.g., the Supreme Court of the state of Delaware in Gantler v. Stephens reversed the Chancery Court’s dismissal of a shareholder complaint alleging conflict of interest and breach of fiduciary duty). While much of this litigation has been prompted by the current political and economic environment, a director’s perceived lack of attention to his or her oversight duties can make him or her a target of both an RCOD criminal prosecution or civil breach of fiduciary duty claims.
What to do?
The re-emergence of the RCOD and the associated increase in the risk in personal liability should prompt directors to examine closely their own mode of operating as a board member. We recommend that directors take a more active posture in educating themselves about law enforcement and regulatory initiatives that focus on their particular industry or company so that they will be in a better position to understand whether the company’s senior management is allocating sufficient resources to corporate compliance initiatives. Board members should focus on how their overall board and board committee roles, such as the audit or compensation committees, create specific oversight responsibilities over key company functions that depend on robust regulatory compliance.
In particular, directors should be motivated to recognize specific “high regulatory compliance risk” situations so that they can evaluate the extent to which they are in a position to influence the actions of corporate subordinates to head off potentially illegal corporate activities. Where there is a direct nexus, such as when dealing with foreign governments, U.S. government contracts, or U.S. regulatory limitations on product development or marketing activities to the public, directors should advocate that key employees receive proper regulatory compliance education, have their actions closely monitored in “real time” by the legal and compliance departments, and seek and receive executive and legal approval before moving forward.
These compliance initiatives often require the allocation of corporate resources to what are perceived as non-revenue creating activities. The reality is, however, that many of these initiatives are critical to the development of an economically sustainable business model for the company and, consequently, a more consistently pleasant and rewarding experience for board members. and other measures intended to prevent lower level managers who report to them from engaging in noncompliant behavior. The likelihood of success in preventing episodes that threaten the existence of the company and pose personal liability to directors is enhanced by insuring that senior management has enabled its employees to have access to regular compliance education and training from qualified internal resources and, where necessary, from the most qualified outside advisors.
T. Reed Stephens is a partner in the Washington, D.C. office of McDermott Will & Emery. He was a Department of Justice trial attorney from 1995 to 2003. Michael Peregrine is a partner with McDermott Will & Emery in the firm’s Chicago office.