The Reverse Agency Problem in the Age of Compliance

Abstract

The agency problem, the idea that corporate directors and officers are motivated to prioritize their self-interest over the interest of their corporation, has had long-lasting impact on corporate law theory and practice. In recent years, however, as federal agencies have stepped up enforcement efforts against corporations, a new problem that is the mirror image of the agency problem has surfaced — the reverse agency problem. The surge in criminal investigations against corporations, combined with the rising popularity of settlement mechanisms including Pretrial Diversion Agreements (PDAs), and corporate plea agreements, has led corporations to sacrifice directors and officers in order to reach settlements with law enforcement authorities as expeditiously as possible.

While such settlements are in the best interest of companies and shareholders, they have devastating effects for individual directors and officers. When settling through agreements, suspect companies usually attribute wrongdoing to a large group of directors and managers, without distinguishing among guilty and innocent individuals, and surrender all their information. As a result, directors and officers implicated in settlements may suffer severe reputational loss and face legal battles brought by corporations. Furthermore, the wrongdoing attributed to directors and officers in settlements expose them to derivative lawsuits for breach of their fiduciary duties. Unfortunately, extant law does not provide directors and officers with a means to prove their innocence or clear their name. In fact, it does not even give them a voice in the negotiations leading to the drafting of settlements. Thus, it dooms many directors and officers who have done no wrong to live with the mark of Cain and endure the economic consequences thereof.

To remedy the plight of individual directors and officers, we suggest three possible legal reforms. The first seeks to amplify the voice of individual corporate officers in settlement negotiations by giving them a right to a hearing prior to the finalization of a settlement. The second is to give directors and officers implicated in settlements the right to bring an action for a declaratory judgment that could clear their name and preempt derivative actions against them. The third solution is to recognize a horizontal fiduciary duty between directors and officers, thereby allowing innocent directors and officers the right to sue their guilty colleagues for breaching such duty.

Keywords: Law and Economics, White Collar Crime, Criminal Procedure, Corporations, Fiduciary Law, Principal-Agent Conflicts, Plea Bargaining, Deferred Prosecution & Non Prosecution Agreements, DPAs, NPAs, Reputational Harm

JEL Classification: G30, G38, K14, K22, K42, L29