This is the second installment of a 3-part series exploring structural solutions to certain deficiencies in corporate cultures that can lead to major wrongdoing.
The Park Doctrine, named after a 1975 US Supreme Court case, allows a corporate officer to be held criminally liable for a violation of the US Federal Food, Drug, and Cosmetic Act (FDCA) by his firm, if the government can demonstrate that he actually occupied a position of responsibility and authority where he could have prevented or corrected such violation.
Such criminal liability can stand “even if such corporate official did not have any actual knowledge of, or participation in, the specific offense”, as stated by the US Food and Drug Administration in its guidelines for such types of prosecutions.
This doctrine is in essence a type of strict criminal liability, aimed at heightening vigilance of corporate officers as to matters affecting public health.
For decades, the Park Doctrine lay dormant but, in recent years, there has been renewed interest on the part of federal prosecutors to use this rule.
Consequently, prosecutors have secured large fines on and/or prison terms for individual officers of several drug and food companies, respectively, and, in one case, career-ending administrative sanctions as well for several executives.
The basis for liability under Park - the executive being in a position to prevent or correct the violation - may seem vague. However, subsequent case law has offered a defense based on the defendant having taken “extraordinary care” to prevent said violation.
While “extraordinary care” also remains to be clearly defined, food and drug companies are being advised to at least beef up FDCA compliance programs and open lines of communication to ensure that potential violations are raised and reported to the proper channels (including upwards). If this advice is widely heeded then Park enforcements may yet yield a benefit in terms of cultural openness.
On 1 July 2015, the US Securities and Exchange Commission (SEC) proposed Rule 10D-1 to implement Section 954 of the Dodd-Frank Act, which requires all companies listed in the US (with limited exceptions) to implement policies to recover incentive-based compensation (clawbacks) received by current or former executive officers in the event of certain financial restatements.
Such compensation is subject to recovery if it is received during any of the three fiscal years completed before the date on which the issuer is required to prepare a financial restatement.
The recovery is against a broadly defined group of “executive officers” regardless of fault or their role in the financial restatement, so long as such individuals served as such at any time during the performance period(s) for the recoverable incentive-based compensation.
The amount of such compensation to be recovered by the issuer from each executive officer is the excess of what was paid to him and what would have been paid had the payout been based on the restated financial information.
Since recovery under the rule depends on status as an executive officer and not on knowledge or intent of the officer, the rule embodies a type of strict liability.
Although the SEC in its final rule may yet refine its definition of “executive officers”, the fairly broad nature of such definition and the strict liability basis of the recovery should stand as they are directly derived from the Dodd-Frank Act (unless the statute itself is amended).
An unintended consequence of the clawbacks, as NY Times reports, is that some corporations may try to cushion their executive officers from the rule by changing the mix of compensation in favor of higher non-incentive-based compensation.
Such maneuver may be understandable as to those executives who have no information on or control over any noncompliance that would lead to the relevant accounting error(s).
For example, the head(s) of the investment bank at a major financial institution may have no information on or control over erroneous accounting treatment of certain trades in the sales and trading area.
Couldn’t the rule be justified based on negating unjust enrichment (i.e. recouping excess compensation due to accounting errors)? Perhaps so, to some extent, but the scope of the rule seems to exceed that objective, as discussed below under the heading “Promising works in progress”, and adverse tax consequences for officers could follow such clawbacks as well.
Incentive-based compensation still has value for many companies. As to them, the clawback rule may have merit to the extent that it penalises executive officers who have control over accounting matters for errors requiring restatements, and incents such officers to foster an environment which facilitates catching such errors early.
Zipes’ enforceable code of conduct
US lawyer Greg Zipes proposed in early 2015 a type of code of conduct with teeth.
Under Zipes’ proposal, a senior officer or director of any listed company could voluntarily enter into a binding agreement that could lead to an “automatic reduction” - for any specified violation - of up to 25% of his gross compensation for the three years preceding such violation.
These violations include (but are not limited to) the following:
the company pleading guilty to or being convicted of a crime for an act that occurs while the executive is at his position when signing the agreement;
the company incurring a fine of more than $10,000,000 for an act that occurs while the executive is at his position when signing the agreement; and
as to an officer who certifies a financial document filed with the SEC, such financial document requiring a restatement in an amount greater than $5 million.
The pay reductions are “automatic” in that they apply whether such executive knew about or participated in the violation. As such, these penalties are in the nature of strict liability.
Zipes argues that customer and/or shareholder demand could drive a company to adopt his regime, and executives to accede to it. Thus, the regime requires no regulatory or law change for its implementation, and is appealing as a market-based solution.
However, in striving to create “bright lines” and “clear guideposts” to allow unambiguous determination of when an automatic reduction should occur, the regime could impose the penalty on all acceding officers, regardless of access to information on or control over the violation. This issue is similar to the one under the clawback rule.
For example, a chief technology officer could incur an automatic reduction if, unbeknownst to him, someone in sales bribed foreign government officials to gain market share, which resulted in a fine of more than $10,000,000 or criminal conviction.
Zipes argues for rough justice as to such type of scenario: just as senior officers partake in their company’s profits without necessarily knowing all the activities that generated such profits, so they should share in the downside of a company’s misconduct, even if they have no knowledge of or involvement in such misconduct.
Nevertheless, by putting an onus on an officer for areas of business as to which he has little control or information, the above type of scenario may lead some executives to eschew such regime on the belief that they can justify the decision to stakeholders.
On the other hand, Zipes’ regime might promote preventive care by an officer as to violations that might fall within his area of responsibility that would lead to automatic reductions.
The next and final installment will examine UK’s Senior Managers Regime and seek to distill useful elements from all the regimes discussed that may enhance senior officers’ dedication to sound risk cultures.
Wilfred Chow is a US-based researcher and writer on corporate responsibility, governance and ethics and sustainability. He previously served as a managing director and associate general counsel at a leading financial services firm in the US.compliance FDCA Wilfred Chow