A bad week for weak compliance programs

“The secret of life is honesty and fair dealing. If you can fake that, you’ve got it made,” Groucho Marx famously said. But having fake C&E programs may not be such a good idea, as two recent important legal developments suggest.

The first involves a case brought by the U.S. Department of Justice against the ratings firm S&P for, among other things, falsely claiming that that company had “established policies and procedures to address the conflicts of interest through a combination of internal controls and disclosure.”  (The original complaint was the subject of an earlier post.)   The company filed a motion to dismiss on the grounds that these claims were mere harmless “puffery” but the court rejected the defense   which it called, in a decision handed down on July 16, “deeply and unavoidably troubling.” (Another judge, in a case decided last year, had called a similar argument by Goldman Sachs “Orwellian,”  and – at least to my mind – this defense has all the absurdity of a Groucho gem without any of the humor.)

As the court noted, S&P’s defense was that, “out of all the public statements that [the company] made to investors, issuers, regulators, and legislators regarding the company’s procedures for providing objective, data-based credit ratings that were unaffected by potential conflicts of interest, not one statement should have been relied upon by investors, issuers, regulators, or legislators who needed to be able to count on objective, data-based credit ratings.” The court concluded: “Despite defendants’ protestations to the contrary, the court cannot find that all of these ‘shalls’ and ‘must nots’ are the mere aspirational musings of a corporation setting out vague goals for its future. Rather, they are specific assertions of current and ongoing policies that stand in stark contrast to the behavior alleged by the government’s complaint.”

Of course, this was merely a motion to dismiss – not a final adjudication on the merits of the government’s claims.  But this decision certainly augers ill for S&P for whenever that day of judgment should arrive, and, given that the government is seeking a $5 billion recovery, this has to be worrisome for the company and the shareholders of its parent entity, McGraw-Hill.

Also of a preliminary nature are the  criminal indictment  handed down last week against the giant hedge fund SAC Capital Advisors for insider trading  and the related SEC administrative case against the firm’s owner, Steven Cohen.  As described in a must-read (for C&E officers, that is) article in yesterday’s NY Times, while SAC has claimed that it had a strong compliance program, the program in fact seemed to be ineffective in many ways.  E.g., the firm supposedly hired many employees precisely because of their possible access to inside information;  the compliance “training seems only to have alerted some employees to the type of activity they needed to conceal”; and the compliance department had little success in  detecting possible insider trading.

Note that the government is not merely saying that SAC shouldn’t get the benefit of a compliance-based defense.  Rather, a faked compliance program is itself alleged to be part of the criminal scheme.

Finally, one obviously cannot predict a trend based on two cases alone. But as I point out in this recent article in Compliance & Ethics Professional, given the escalating costs of non-compliance generally we are likely to see more cases involving claims of compliance fakery in the future – for the simple reasons that the companies and executives who don’t grasp the logic of having an effective compliance program may perceive a growing incentive to conceal compliance shortfalls, i.e., a true vicious circle.   Even Groucho would have a hard time finding a joke in that.