Federal agencies and prosecutors are being criticized for seeking so few indictments against individuals in the wake of the 2008 financial crisis and its resulting banking failures. This article analyzes why—contrary to a longstanding historical trend—personal liability may be on the decline, and whether agencies and prosecutors should be doing more. The analysis confronts fundamental policy questions concerning changing corporate and social norms. The public and the media perceive the crisis’s harm as a “wrong” caused by excessive risk-taking. But that view can be too simplistic, ignoring the reality that firms must take greater risks to try to innovate and create value in the increasingly competitive and complex global economy. This article examines how law should control that risk-taking and internalize its costs without impeding broader economic progress, focusing on two key elements of that inquiry: the extent to which corporate risk-taking should be regarded as excessive, and the extent to which personal liability should be used to control that excessive risk-taking.
Posts Tagged ‘Corporate liability’
The announcement of the Credit Suisse guilty plea on May 19, 2014 marks the first time in more than a decade that a large financial institution has been convicted of a financial crime in the United States. For this reason alone, some will herald it a watershed moment in the history of corporate criminal liability. But the government’s well-publicized efforts to mitigate the collateral consequences resulting from the plea will likely limit the plea’s practical significance for companies that find themselves in the unenviable position of negotiating a resolution of criminal allegations with the government. This post will explore the potential implications of the Credit Suisse guilty plea for corporate criminal liability.
The doctrine of piercing the corporate veil is shrouded in misperception and confusion. On the one hand, courts understand the fact that the corporate form is supposed to be a juridical entity with the characteristic of legal “personhood.” As such courts acknowledge that their equitable authority to pierce the corporate veil is to be exercised “reluctantly” and “cautiously.”  Similarly, courts also recognize that it is perfectly legitimate to create a corporation or other form of limited liability company business organization such as an LLC “for the very purpose of escaping personal liability” for the debts incurred by the enterprise. 
“This Order contains no findings that an officer, director or employee of Alcoa knowingly engaged in the bribe scheme.”
There are several notable aspects of aluminum producer Alcoa, Inc.’s (“Alcoa”) recent FCPA settlement. The $384 million in penalties, forfeitures and disgorgement qualify as the fifth largest FCPA case to date. Further, it is remarkable that such a large monetary sanction was imposed when the criminal charges brought by the U.K. Serious Fraud Office against the consultant central to the alleged bribery scheme were dismissed on the grounds that there was no “realistic prospect of conviction.” Perhaps most striking, however, is the theory of parent corporate liability that the settlement reflects. Although there is no allegation that an Alcoa official participated in, or knew of, the improper payments made by its subsidiaries, the government held the parent corporation liable for FCPA anti-bribery violations under purported “agency” principles. Alcoa serves as an important marker in what appears to be a steady progression toward a strict liability FCPA regime.
Every firm is exposed to business risks, including the possibilities of large, adverse shocks to cash flows. Potential sources for such shocks abound—examples include disruptive product innovations, the relaxation of international trade barriers, and changes in government regulations. In our paper, CEO Compensation and Corporate Risk: Evidence from a Natural Experiment, forthcoming in the Journal of Accounting and Economics, we examine (1) how boards adjust CEOs’ exposure to their firms’ risk after the risk of such shocks increase and (2) how incentives given by the CEOs’ pre-existing portfolios of stock and options affect their firms’ response to this risk. Specifically, we study what happens when a firm learns that it is exposing workers to carcinogens, which increase the risks of significant corporate legal liability and costly workplace regulations.
The results presented in this paper suggest that corporate boards respond quickly to changes in their firms’ business risk by adjusting the structure of CEOs’ compensation, but that the changes only slowly impact the overall portfolio incentives CEOs face. After the unexpected increase in left-tail risk, corporate boards reduce CEOs exposure to their firms’ risk; the sensitivities of the flow of managers’ annual compensation to stock price movements and to return volatility decrease. Various factors likely contribute to the board’s decision, including CEOs’ reduced willingness to accept a large exposure to their firms’ risk and the decline in shareholders’ desired investment after left-tail risk increases. Indeed, managers act to further reduce their exposure to the firm’s risk by exercising more options than do managers of unexposed firms. These changes, however, only slowly move CEOs’ overall exposure to their firm’s risk because the magnitude of their pre-existing portfolios continues to influence their financial exposure to the firm.
On September 23, 2013, the United States Court of Appeals for the Second Circuit issued a decision clarifying the standard for aiding and abetting liability under the Commodities Exchange Act (“CEA”). The decision, in In re Amaranth Natural Gas Commodities Litigation, No. 12-2075-cv (2d Cir. Sept. 23, 2013), affirmed a judgment of the United States District Court for the Southern District of New York, which dismissed a putative class action filed by purchasers of natural gas futures contracts against J.P. Morgan Chase & Co., J.P. Morgan Chase Bank, Inc. and J.P. Morgan Futures, Inc. (“JPMorgan”). The purchaser plaintiffs claimed that Amaranth, a hedge fund for which JPMorgan provided clearing broker services, manipulated natural gas futures prices on the NYMEX commodities exchange, and that JPMorgan aided and abetted Amaranth’s manipulation.
On August 30, 2013, the United States Court of Appeals for the Second Circuit unanimously held that Section 10(b) of the Securities Exchange Act of 1934 (“Section 10(b)”) does not apply to extraterritorial conduct, “regardless of whether liability is sought criminally or civilly.” Interpreting the scope of the Supreme Court’s landmark ruling in Morrison v. National Australian Bank Ltd.,  the Second Circuit’s significant decision in United States v. Vilar, et al. means that a criminal defendant may be convicted of fraud under Section 10(b) only if the defendant engaged in fraud “in connection with” a security listed on a United States exchange or a security “purchased or sold” in the United States. In reaching its conclusion, the court rejected the government’s attempts to distinguish criminal liability under Section 10(b) from the civil liability at issue in Morrison, holding that “[a] statute either applies extraterritorially or it does not, and once it is determined that a statute does not apply extraterritorially, the only question we must answer in the individual case is whether the relevant conduct occurred in the territory of a foreign sovereign.”
One of the most difficult, and therefore most heavily negotiated, issues in carve-out transactions is the division of liabilities between the parent and the carved-out business. Typically, the division of liabilities will follow the business: liabilities attributable to the parent’s business will be retained by the parent, and liabilities attributable to the subsidiary or division’s business will be assigned to the subsidiary or division. As explained below, in the case of an M&A transaction, this application can vary depending on whether the transaction is a stock sale or an asset sale. 
- Stock Sale. In a stock sale, liabilities of the carved-out entity typically pass to the buyer by operation of law. The carved-out entity is acquired “as is” with all of its existing liabilities. However, to the extent the parent is creditworthy, the buyer may be able to obtain protection from certain liabilities through indemnification.
- Asset Sale. In an asset sale, by contrast, the buyer is contractually responsible only for those liabilities that it specifically assumes as part of the negotiated asset purchase agreement. This flexibility allows the parties to choose from any number of liability arrangements, from “all liabilities resulting from the ownership and operation of the carved-out division” to only specifically enumerated liabilities in a schedule, with the parent typically providing unlimited indemnification for all other liabilities. However, even where the buyer does not expressly agree to assume any liabilities, the buyer should be aware that it may nonetheless be subject to certain successor liabilities arising out of the asset purchase. 
- Applicable Law. No matter what the transaction structure, both parties should be aware that under applicable state, federal or international law, certain environmental, product and employee liabilities may pass to the buyer or be retained by the parent even if the parties have contractually provided for another allocation.
In December 2012, we published an Alert after a Federal District Court concluded that: (1) a private equity fund was not a “trade or business” for purposes of determining whether the fund could be liable under the Employee Retirement Income Security Act of 1974 (“ERISA”) for the pension obligations of one of its portfolio companies and (2) consequently, the private equity fund could not be liable for its portfolio company’s pension obligations under Title IV of ERISA, even if the fund and the portfolio company were part of the same “controlled group.” Our December Alert, which contains background on the issue and a summary of the state of the law through December 2012, may be found here. This post is to advise that the First Circuit Court of Appeals has reversed the 2012 Federal District Court opinion.
In Sun Capital Partners III LP v. New England Teamsters & Trucking Indus. Pension Fund (No. 12-2312, July 24, 2013), the First Circuit Court of Appeals has concluded that: (a) a private equity fund can be a “trade or business” for purposes of determining “controlled group” joint and several liability under ERISA and (b) as a result, the private equity fund could be held liable for the pension obligations of its portfolio company under Title IV of ERISA, if certain other tests are satisfied. Under ERISA, a “trade or business” within a “controlled group” can be liable for the ERISA Title IV pension obligations (including withdrawal liability for union multiemployer plans) of any other member of the controlled group. This “controlled group” liability represents one of the few situations in which one entity’s liability can be imposed upon another simply because the entities are united by common ownership, but in order for such joint and several liability to be imposed, two tests must be satisfied: (1) the entity on which such liability is to be imposed must be a “trade or business” and (2) a “controlled group” relationship must exist among such entity and the pension plan sponsor or the contributing employer.
Private equity funds (PE funds) and their advisors long have been concerned that a fund (or its other portfolio companies) may be liable for unfunded pension plan liabilities of one of its portfolio companies. However, in a decision published last month, the U.S. District Court of Massachusetts held that three PE funds sponsored by Sun Capital were not liable for any portion of the withdrawal liability incurred by a portfolio company in which the funds collectively held a controlling interest. In reaching this decision, the court expressly rejected the analysis contained in a 2007 Pension Benefit Guaranty Corporation (PBGC) Appeals Board opinion, which found that the investment activities of a PE fund constitute a “trade or business” and thus subjected the PE funds to joint and several liability under Title IV of the Employee Retirement Income Security Act (ERISA) for a portfolio company’s unfunded pension liabilities.
Although the Sun Capital Partners case provides a foundation for cautious optimism on the issue of whether PE funds can be held jointly and severally liable for the pension-related liabilities incurred by portfolio companies in which they invest, it remains to be seen whether its analysis will be adopted by other courts and whether the district court’s decision will be upheld on appeal to the First Circuit. PE funds should continue to view control group liability as a potential risk in the acquisition context and, in order to minimize exposure to unfunded pension liabilities, PE funds should consult counsel when encountering these issues.