The Cost of Cooperating Just Went Up for Companies

Cooperating with a government investigation sounds like a good idea, but it can cost companies quite a bit of money.

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Peter J. Henning
, New York Times

Cooperating with a government investigation sounds like a good idea, but it can cost companies quite a bit of money.

A recent decision by the Supreme Court, in Lagos v. United States, will make life more difficult for corporations hoping to recoup some of those costs from employees who violated the law.

The Justice Department puts a premium on corporate cooperation. Its “Principles of Federal Prosecution of Business Organizations” assert that “for a company to receive any consideration for cooperation under this section, the company must identify all individuals involved in or responsible for the misconduct.” Rod J. Rosenstein, the deputy attorney general, reiterated the point in a speech last month, saying that “corporate America should regard law enforcement as an ally.”

That ally does not come cheap, however.

The Lagos case concerned a provision of the Mandatory Victims Restitution Act, which required a defendant to reimburse a victim for “lost income and necessary child care, transportation and other expenses incurred during participation in the investigation or prosecution of the offense or attendance at proceedings related to the offense.” Sergio Fernando Lagos was convicted of defrauding General Electric Capital out of millions of dollars by submitting false invoices to draw down loans. The District Court ordered him to repay the company about $5 million in legal and accounting fees it incurred conducting an internal investigation into the fraud and dealing with his company’s bankruptcy.

In recent years, federal courts had taken a broad view of what “other expenses” could be reimbursed when corporations were caught up in an investigation. In U.S. v. Gupta, the U.S. District Court in Manhattan ordered Rajat K. Gupta, a former director of Goldman Sachs convicted of tipping confidential information used for insider trading, to repay the firm over $6 million it incurred helping prosecutors and the Securities and Exchange Commission in their investigations. In U.S. v. Skowron, the federal appeals court in Manhattan upheld an order requiring Joseph F. Skowron III to repay Morgan Stanley $3.8 million in legal fees from its internal investigation, which helped the SEC in the insider trading case that resulted in a guilty plea.

The Supreme Court took a decidedly narrower view of what “necessary” expenses could be the subject of mandatory restitution. It rejected the view that costs associated with an internal corporate investigation come within the statute. The justices held unanimously that “investigations” and “proceedings” are limited to criminal prosecutions and do not include other types of inquiries that a company might undertake to aid the government.

Also, those costs are not subject to a mandatory restitution order if they are for civil or regulatory proceedings, like an SEC investigation, because “the statute says nothing about the kinds of expenses a victim would often incur when private investigations or, say, bankruptcy proceedings are at issue, namely, the costs of hiring private investigators, attorneys or accountants.”

The court adopted its “narrower construction” to avoid requiring lower courts to figure out what costs are — or are not — truly necessary. As a result, unless the Justice Department demands that a company take certain steps, the cost of being proactive in ferreting out misconduct in an organization will not be subject to mandatory restitution by a defendant.

The Supreme Court pointed out that General Electric Capital was not bereft of other remedies. The company obtained a judgment for over $30 million against Lagos in a lawsuit. But as lawyers know well, a defendant sitting in prison whose company went into bankruptcy is unlikely to have anything available to pay off such a judgment — short of winning the lottery or writing the next great American novel one day.

The Lagos decision puts most of the costs of an internal investigation beyond the reach of the restitution statute, so that companies can no longer look to individual defendants for repayment. In an era when there are often multiple civil investigations along with potential criminal prosecutions for corporate misconduct, a company hoping to be viewed as cooperative may need to consider how much it is willing to pay to show how accommodating it truly is to the government’s interests.

The Supreme Court’s decision in Lagos is just the latest in a line of cases that have made it more difficult to obtain repayment for misconduct. In Kokesh v. Securities and Exchange Commission, decided last June, the Supreme Court limited to five years the period in which the SEC could sue for the return of ill-gotten gains under the applicable statute of limitation. In testimony last month in Congress, Stephanie Avakian and Steven Peikin, co-directors of the enforcement division, said that “it is likely that Kokesh will have a significant impact on our ability to enforce the federal securities laws and obtain recovery for harmed investors in long-running frauds.”

Congress can change the statutes to reverse the outcomes of the Lagos and Kokesh cases. But whether there is any appetite on Capitol Hill to help curtail corporate misconduct by allowing for the recovery of internal investigation costs or the gains from securities fraud remains to be seen. In an environment of greater deregulation and diminished enforcement, the federal government may have to live with the limitations imposed by the Supreme Court.

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