TheCorporateCounsel.net

This week, I am looking back on almost thirty years of practice and offering up some of the key lessons that I have learned over the course of my career. Today, I am focusing on what I think of as the era of corporate scandals, which was the period of time in the early 2000s when we experienced a large number of corporate scandals that rocked the markets, eroded investor confidence and prompted Congress to act in a bipartisan manner to enact sweeping legislative initiatives that are still very much a part of the fabric of what we do today, nearly a quarter century later. I am of course talking about the spate of high profile financial, disclosure and governance failures at Enron, WorldCom, Tyco, Adelphia, Global Crossing and others. I had the unique experience of seeing these scandals upfront while in private practice, and then dealing with the aftermath when I was back at the SEC for my second tour.

By the early 2000s, I had left the SEC and was in private practice at a firm that seemed to be handling most of the extraordinary corporate scandals of the day. I was incredibly fortunate to have an opportunity to work with a fantastic group of lawyers and other professionals who taught me so much about conducting investigations, addressing intense regulatory and law enforcement attention, managing a crisis and navigating a wide range of incredibly complex regulatory, financial market, governance and ethics issues. With the benefit of that experience and similar experience that I have had since the early 2000s, I offer up a few of my favorite lessons learned:

1. Don’t Violate the First Law of Holes: Those of you who have read my musings here (and in our other publications) have no doubt noticed that I have penchant for using all manner of adages and aphorisms. One of my favorite ones is “the first law of holes,” which goes something along the lines of “when you find yourself in a hole, you should stop digging.” Unfortunately, time and time again, we have observed that corporate executives, directors and employees just can’t seem to avoid violating the first law of holes, and that is how scandals happen. While there are plenty of situations where individuals set out to defraud investors from the outset, there are also plenty of situations where something gets pushed close to the line in one quarter, and then the individuals find themselves digging their hole deeper and deeper in each successive quarter, because they think that they can ultimately dig their way out when circumstances change. This phenomenon really emphasizes the need for effective controls and good governance, so that the individuals are not tempted (or do not feel compelled) to fall into the hole in the first place. And once the potentially illegal conduct has been discovered, it is critical for counsel and other professionals assisting with the crisis to help prevent the company from falling into new holes, or deepening the hole that it already finds itself in. Otherwise, things can go very bad, very quickly, as we saw with those early 2000s corporate scandals.

2. The Cover-up is Worse than the Crime: To borrow a ubiquitous Watergate-era adage, one often observes in the course of a corporate crisis that nothing can be more true than the notion that “the cover-up is worse than the crime.” Efforts to conceal potentially illegal conduct during the course of a crisis always makes things worse for everyone involved, and always puts the board of directors and senior management in a difficult spot with respect to those individuals involved in the conduct. Over the years, I have observed numerous situations where transparency around the subject conduct might have avoided catastrophic consequences, so that is why it critically important that a company’s control environment and governance structure encourages transparency at all levels, even when the going gets tough.

3. It’s All About the Benjamins: I have not run across too many corporate scandal situations where an individual was engaging in the illegal activity purely for the fun of it. There is usually a financial incentive that serves to motivate the unlawful behavior. Since the corporate scandals of the early 2000s, I think that we have collectively gotten much better at structuring compensation programs that seek to address the risk of incentivizing illegal conduct, but no compensation approach is ever perfect, and for each individual involved there are often a variety of motivating factors that have caused them to go astray. I do think that it is incumbent on boards and compensation committee to always consider the risk that financial incentives could encourage bad behavior and take steps to minimize that risk as much as possible under the circumstances.

4. Human, All Too Human: The title of one of my favorite Friedrich Nietzsche books (perhaps because it was written in an aphoristic style?) serves as a reminder that, until artificial intelligence is in a position to replace us in preparing and auditing financial statements and writing SEC disclosure, us humans are going to continue to hack away at it, and we are going to make mistakes. Unfortunately, human nature doesn’t always encourage us to admit our mistakes or exercise good judgment. This is particularly the case when our financial livelihood, professional reputation and self-esteem are on the line. The human element must always be anticipated, and that is why we have such extensive controls in place today in the wake of the Sarbanes-Oxley Act. We should never forget that we are all humans that can (and often do) fail, but we should make sure that no single human’s failure is going to send the company spinning into a corporate scandal.

5. Be Creative When Faced with Calamity: One of the most significant responses to the crisis in market confidence brought about by the early 2000s corporate scandals was when the SEC issued an emergency order under Section 21(a) of the Exchange Act which imposed a one-time certification requirement on CEOs and CFOs of public companies with revenue of $1.2 billion or more. The sworn statements demanded by the order were intended to restore confidence in the financial statements of large public companies and became the model for the certifications later required by the Sarbanes-Oxley Act and SEC rules. There was no precedent for this creative approach taken by the SEC, and it highlighted how important it can be to think “outside of the box” when faced with a crisis situation.

– Dave Lynn