Corporations should expect an onslaught of enforcement proceedings from investigations into overseas bribery, manipulation of financial benchmarks and the issuance of toxic mortgage securities. The question is how much money the government will demand as part of the inevitable settlements, a figure that is difficult to calculate.
The government is taking an increasingly hard line in seeking large settlements, as shown by the litigation reserves companies are required to set up once they have determined the cost of resolving a case. What we don’t really know, however, is what goes into the process of assessing a penalty and how it relates to the harm caused by a violation.
Last week, two companies disclosed significant increases in their reserves as a step toward concluding government investigations. BNP Paribas, the French bank, disclosed that it has set aside $1.1 billion to resolve federal and state investigations into whether it violated economic sanctions laws that prohibit dealing with businesses in countries like Iran, Cuba and Sudan.
Avon Products said that it had set aside $89 million to cover a possible settlement of an investigation into violations of the Foreign Corrupt Practices Act by the Justice Department and Securities and Exchange Commission. Even that might not be enough; its chief executive, Sheri McCoy, noted the penalties could go as high as $132 million.
The announcement of Avon’s reserve is interesting in light of the company’s earlier disclosure in June 2013 that the Justice Department and S.E.C. had rejected an offer of $12 million to settle the case. It looks as if Avon tried to lowball the government, and now the potential payment could end up coming in at more than 10 times its initial offer.
Accounting rules require a company to disclose a material loss because of litigation once it is both probable and the amount can be reasonably estimated. When that line is crossed is a matter of judgment, but once the parameters of a deal with the government are in place, a company can be expected to disclose how much it thinks it will have to pay.
How the two sides arrive at the penalty remains something of a mystery to the general public. Companies rarely disclose what happened in the negotiations, as Avon did.
Federal statutes provide the maximum fine for a violation, but that is only for a single violation. Corporate crime often involves hundreds, or even thousands, of separate offenses, so the total potential fine could be enormous.
The federal sentencing guidelines provide a set of factors to be considered when a court determines a financial penalty. The list includes whether a company cooperated in the investigation and the involvement of senior management in the crime.
But few cases involving large corporations ever see the inside of a courtroom. Instead, the Justice Department usually resolves corporate investigations through deferred and nonprosecution agreements, along with civil settlements, that do not require judicial approval of any penalty assessed against a company. So it is often unclear how the government determined the amount to be paid as the punishment for a violation.
The Wall Street watchdog Better Markets challenged the government’s recent $13 billion settlement with JPMorgan Chase over its sales of mortgage securities, which included a $2 billion civil penalty. The organization filed a lawsuit in Federal District Court in Washington, contending that the absence of any judicial review of the agreement violates federal law and the Constitution. The basic complaint is that the Justice Department “acted as investigator, prosecutor, judge, jury, sentencer, and collector, without any check on its authority or actions.†[link below]
The lawsuit faces substantial hurdles that make it unlikely to succeed. As a general matter, private parties do not have standing to challenge a decision by the government to settle a case. The Justice Department has broad discretion in how it chooses to exercise its authority, and courts rarely intervene to scrutinize a decision unless there is evidence involving improper discrimination.
Nevertheless, the frustration expressed by Better Markets about the process for determining what JPMorgan should have paid to resolve multiple investigations is fair. As I discussed in an earlier column, it is unclear how the Justice Department arrived at the nice round figure of $2 billion for the civil penalty or what specific violations led to that particular punishment.
Disclosure of litigation reserves usually comes near the end of the negotiation process because only then can a company reasonably estimate what it will have to pay. Even that disclosure is usually tempered with the caveat that the final settlement could be higher because a company never knows when the government will demand more.
What we don’t learn is how extensive the government believes the misconduct was or how it determined the appropriate punishment for the violation. The statement of facts in the settlement is carefully crafted to reveal only the minimum amount of wrongdoing to support the imposition of a penalty.
We are sure to see even more cases in the coming months as banks deal with the fallout from investigations into manipulation of the London interbank offered rate, or Libor, and foreign exchange prices. We have already seen a number of executives fired or put on leave for their involvement in manipulation of currency exchange rates, a harbinger of settlements that will impose significant monetary penalties.
How much they have to pay remains to be seen, and at this point it is a matter of guesswork for all involved in the process. Without outside scrutiny of the terms of the agreements to resolve investigations, it is anyone’s guess how much the government will be satisfied with as the punishment, or what violations will be found.
As it stands, we have to rely on corporate disclosures to get a sense of the likely cost of an investigation. As usual, the government stands largely mute about what happened or why a particular punishment is appropriate.
