Cindy Alexander and Jennifer Arlen Abstract · 2017-10-12 · Vasile and Jerry Goldsmith. Jennifer Arlen is grateful for the financial support of the D’Agostino/Greenberg Fund of

DOES CONVICTION MATTER? THE REPUTATIONAL AND COLLATERAL EFFECTS OF CORPORATE CRIME

Cindy Alexander and Jennifer Arlen

Abstract

Critics of deferred prosecution agreements claim they undermine deterrence by lowering the cost to firms from reputational damage or stigma resulting from a criminal settlement. We evaluate whether the choice between a DPA and a guilty plea affects the cost to corporations of reputational damage arising from the reactions of interested outsiders – e.g., customers and suppliers – to the settlement, holding constant other factors such as the offender and offense magnitude. We introduce a framework for this purpose in which differences in the qualitative information that is released at settlement may cause differences in outsider reaction and, thus, the firm’s cost of reputational damage. We review the contents of the DPA and plea agreements and find no differences in the information they directly convey to interested outsiders that would cause differences in the expected cost of reputational damage to the firm. We then identify three channels through which the choice of settlement form might indirectly signal information to outsiders: direct revelation, prosecutorial selection, and managerial selection. The differences in the information that interested outsiders may receive through these channels according to the form of settlement appear unlikely to cause differences in the expected costs of reputational damage between DPA and plea to firms at settlement, however. We then turn to the impact of DPAs on the ability of federal agencies acting as interested outsiders to protect their interests by excluding or delicensing a firm whose criminal settlement reveals that it presents an enhanced risk of causing future harm to the agencies’ interests that is best addressed by exclusion instead of by mandated reforms. We conclude that agencies may be better able to serve their interests as interested outsiders when prosecutors employ DPAs than pleas because DPAs leave many agencies free to use permissive exclusion and enable them to exclude when, but only when, appropriate.

DOES CONVICTION MATTER? THE REPUTATIONAL AND COLLATERAL EFFECTS OF CORPORATE CRIME

Cindy Alexander* and Jennifer Arlen**

1. Introduction

In the United States, prosecutors can convict a corporation for any illegal acts committed by any of its employees, in the scope of employment, with some intent to benefit the firm. 1 Yet notwithstanding their broad authority to convict corporations, U.S. prosecutors regularly resolve corporate criminal cases without formally convicting the firm, through the use of deferred prosecution agreements (DPAs). DPAs enable prosecutors to impose criminal sanctions without convicting the firm.2

* Research Fellow, Law & Economics Center, George Mason University. Alexander thanks James

Cooper and the staff of the Law & Economics Center for their support for the portions of the DPA study that led to this chapter, colleagues at the SEC for their review and comments on prior version of this paper and former colleagues at the DOJ and CEA, Miriam Baer, Mark Cohen, Jon Karpoff, Alex Lee, Dan Klerman, and David Reiffen for helpful discussions. The SEC disclaims responsibility for any private publication or statement by any of its employees. This paper expresses the views of the authors and does not necessarily reflect the views of the Commission of the authors’ colleagues upon the staff of the Commission.

** Norma Z. Paige Professor of Law, New York University School of Law and Director, NYU Program on Corporate Compliance and Enforcement.

This paper was prepared for a conference on Corporate Crime and Financial Misdealing, at the New York University School of Law. We would like to thank the following for their helpful comments and discussions: Danny Alter, George Canellos, Greg Demske, Mark Goodman, Marcel Kahan, Jeffrey Knox, Michael Loucks, Geoffrey Miller, Jonathan Olin, Daniel Richman and participants at the American Law and Economics Association annual meeting, the NYU Program on Corporate Compliance and Enforcement Conference on Corporate Crime and Financial Misdealing, and at faculty workshops hosted by ETH/ESCB Europe and UCLA School of Law. We also would like to thank our excellent research assistants Cristina Vasile and Jerry Goldsmith. Jennifer Arlen is grateful for the financial support of the D’Agostino/Greenberg Fund of New York University School of Law.

1 See New York Cent. and Hudson River R.R. Co. v. United States., 212 U.S. 481, 493 (1909). The corporation can be convicted even if the crime violated corporate policy and the firm had an effective compliance program. E.g., United States v. Basic Constr. Co., 711 F.2d 570, 573 (4th Cir. 1983); United States v. Twentieth Century Fox Film Corp., 882 F.2d 656 (2d Cir. 1989); United States v. Potter, 463 F.3d 9 (1st Cir. 2006); United States v. Ionia Mgmt. S.A., 555 F.3d 303 (2d Cir. 2009); accord US Attorney’s Manuel, Section 9-28.800 (The existence of a corporate compliance program, even one that specifically prohibited the very conduct in question, does not absolve the corporation from criminal liability under the doctrine of respondeat superior).

By contrast, most other countries narrow corporate liability in one of three ways. Some, for example France, only hold corporations criminally liable if the crime was committed by an employee in the “directing mind” of the firm. Others, for example Italy and Chile, do not hold a corporation criminally liable if had an effective compliance program. A final group of countries (including 12 OECD countries), does not impose criminal liability on firms at all, though some of those, such as Germany, impose administrative or civil sanctions with many of the core features of corporate criminal liability, including the threat of exclusion and delicensing. OECD (2016).

2 Under a DPA, the prosecutor files criminal charges but agrees not to seek conviction so long as the

Does Conviction Matter? 2

A policy of enabling prosecutors to use DPAs as an alternative to plea agreements can enhance the general and specific deterrence of corporate crime. Yet some scholars claim that DPAs weaken deterrence3 because DPAs lack the stigmatizing effect of a corporate conviction (Uhlmann 2013, at 1335; Garrett 2014; see Garrett 2007); thus their use lowers the cost to firms of reputational damage arising from a criminal settlement.4

This chapter evaluates the claim that criminal settlements through a DPA impose lower costs from reputational damage or stigma on firms than criminal settlements through a guilty plea, holding all else constant (e.g., the firm, charges, statement of facts, sanctions, and mandates).5 Corporations sustain costs from reputational damage when “interested outsiders”—e.g., customer and suppliers—conclude, based on information released by the criminal settlement, that they face an enhanced risk of harm from future dealings with the firm and thus should take their business elsewhere absent concessions or reforms that are costly for the firm to provide.6 To evaluate whether a change in the form of settlement could lead to a change in the cost of reputational damage to the firm, we consider whether the choice between DPA and Plea might cause a change in the information that outsiders receive about the firm bearing on its likelihood of committing a future offense.

For this purpose, we introduce a framework for evaluating differences in the qualitative information that is released under different forms of settlement, focusing on those differences that appear likely to influence the outsider reaction and thus the expected cost of reputational damage from the settlement to the firm. Corporate criminal settlement agreements provide extensive qualitative information that interested outsiders can use when evaluating the risk of harm to them from a future offense by the firm. This information includes: the nature of the crime (e.g., whether it harmed other similarly situated interested outsiders), the corporation’s responsible relationship to the crime (including the effectiveness of the firm’s compliance program), the nexus between the source of the misconduct and the corporate activities affecting the interested outsiders, the firm’s actions and voluntary reforms once the crime was detected, and the effectiveness of any reforms and undertakings mandated by the agreement.

firm satisfies the terms of the agreement. Under an NPA, the prosecutor agrees not to charge the firm so long as it satisfies the agreement. See, e.g., Greenblum (2005), Garrett (2007), Arlen (2012a), Alexander and Cohen (2015).

3 According to Uhlmann, prosecutors “achieve less in terms of punishment and deterrence when we enter deferred prosecution and non-prosecution agreements.” (2013, at 1336).

4 Critics’ claim that lowering the reputational sanction undermines deterrence assumes that higher total sanctions necessarily deter more crime. Higher total sanctions can indeed promote general deterrence, although there are circumstances under which the opposite effect can occur. Specifically, when corporations are strictly liable for crimes committed in the scope of employment, then higher sanctions can deter firms from detecting, fully investigating and self-reporting crime, thereby potentially reducing the expected sanction imposed on individuals contemplating misconduct (Arlen 2012a, pp. 183-84).

5 Throughout this Chapter we focus on corporations characterized by a separation of ownership and day-to-day control.

6 We refer to those outsiders whose reactions affect the cost to the firm of the settlement as interested outsiders.

ALEXANDER AND ARLEN 3

To evaluate whether an outsider might react differently to a DPA than to a plea agreement, we consider whether settlement through a plea reveals information that the firm presents an enhanced risk of causing a future harm that would not be revealed if the firm settled through a DPA. To assess this, we review the decisions of the prosecutor and firm that lead to the settlement and, thus, may affect its form and content. We identify three distinct hypotheses about the channel through which the choice of settlement form (plea versus DPA) potentially could affect the information revealed to interested outsiders about the risk of harm from future dealings with the firm in this setting.

The first, the direct revelation hypothesis, posits that information about future risk revealed by plea agreements is either more reliable or more salient than the information produced by a DPA. We find no intrinsic differences in the conditions that surround the choice of a plea and DPA settlement to support a conclusion that pleas provide more credible or salient information about future risk. Both pleas and DPAs can contain the same information about the factors bearing on anticipated risk; both agreements contain negotiated charges, facts and sanctions; and press coverage appears to be more closely tied to the magnitude of the sanction, the harm caused, and the salience of the corporation than to the type of agreement.

Under the second, the prosecutor selection hypothesis, the prosecutor’s decision to pursue conviction, instead of a DPA, provides a signal to interested outsiders that the prosecutor observed information that the firm presents an enhanced greater risk of harming them through future misconduct. This hypothesis could hold if, for example, prosecutors only enter into pleas when there is a high risk of a repeat offense. We find no support for this hypothesis. Our review of the considerations that drive prosecutors’ choices of settlement form reveals that choice depends on considerations that appear unrelated to the risk of future misconduct. Specifically, the choice depends most strongly on three considerations: whether conviction could trigger exclusion or delicensing of the firm, whether the firm self-reported misconduct, and whether the firm provided full material cooperation to government investigators. These focal considerations determining whether the prosecutor seeks a plea do not appear to systematically indicate that the firm presents a higher risk of future harm; thus interested outsiders should be unlikely to rely on prosecutors’ choices based on these considerations as a signal of the risk of such harm.

Indeed, in contrast with the prosecutorial selection hypothesis, both forms of settlement – plea agreements and not just DPAs – contain information about a host of corporate reforms—both voluntary and those mandated by prosecutors—that are designed to deter the future misconduct. These include compliance program improvements and monitorships (Arlen 2012a, Alexander and Cohen 2015; Arlen and Kahan 2017; see Alexander 1999; Khanna and Dickerson 2007; Garrett 2007). The mandates, which can be imposed through a guilty plea or a DPA, are relevant for two reasons. First, certain mandates (such as monitors) may provide a superior signal of the firm’s future risk of misconduct when the settlement is announced if, and to the extent employ them when they believe the firm presents an enhanced risk of future misconduct. Second, mandated reforms that outsiders expect to be effective should alter outsiders’ expected risk of dealing with


the firm in the future. Indeed, in principle a convicted firm subject to intrusive mandates could present a lower expected risk of future harm than a similar firm without detected misconduct.

The third hypothesis, managerial selection, posits that pleas may signal that the firm’s managers are more likely to offend in the future on the grounds that senior managers are systematically more willing to accept a guilty plea when they have hidden information their own complicity in the misconduct and can obtain insulation from the risk of individual liability by allowing the firm to plead guilty. This hypothesis is unlikely to hold given two institutional features of corporate criminal negotiations. First, when senior managers are potentially implicated, firms tend to delegate criminal settlements to a committee of disinterested directors, who would breach their fiduciary duties, and face potential personal liability, if they decided to accept a corporate guilty plea in order to provide personal benefits to management. Second, federal prosecutors are directed to pursue individual convictions and must report decisions concerning individuals to supervisors.7 Moreover, even if this did occur, it would not support critics’ claim that the use of pleas leads to enhanced deterrence of corporate crime through their impact on reputational damage costs. To the contrary, here pleas produce a higher cost of reputational damage only because of an assumed prosecutorial willingness to undermine deterrence (by protecting wrongdoers) in order to obtain a plea.

Thus, interested outsiders with discretion to respond to criminal settlements should not interpret the prosecutor’s choice of a plea, rather than a DPA as a signal that the firm is more likely to engage in future misconduct. Nor should the outsider interpret any observed preference of management for a plea as such a signal. While interested outsiders may react to news of a criminal settlement by taking their business elsewhere—thereby imposing costs from reputational damage on the firm— this does not appear to be any more likely to occur if the settlement is a plea than if it is a DPA, other things equal. Instead, the self-interested response of the interested outsider is to consider other information, contained in the settlement document, regarding the firm’s future risk of misconduct. An example is the effectiveness of any mandates that are imposed by the agreement and expressly designed to affect the chance of future misconduct by the offending firm.

Our analysis is not complete, however, without considering the reactions of federal agencies. Federal agencies often operate as direct and indirect counter parties to corporations and have incentives not to deal with firms likely to harm their interests in the future. Federal agencies with discretion would respond when they obtain information that the firm presents a future risk of harm, but may employ a less costly response than exclusion or delicensing: mandates designed to reduce the future risk of misconduct. The choice of DPAs versus pleas should not affect that choice. Of course, federal agencies often are constrained by laws that determine when the agency may or must exclude a firm from

7 Sally Quillian Yates, Memorandum, Individual Accountability for Corporate Wrongdoing (September 9, 2015) (hereinafter the Yates Memo) https://www.justice.gov/ archives/dag/file/769036/ download.


dealing with the agency or particular markets. Conviction may trigger permissive or mandatory exclusion. DPAs, in and of themselves do not. We evaluate whether DPAs undermine agencies’ ability to exclude firms when it would serve their interests and conclude they do not for two reasons. First, when a firm is charged with an offense against the agency’s interests, the agency generally has its own authority to determine that the firm violated the law and, even if the firm was convicted, generally is supposed to engage in its own assessment of whether the firm presents an excessive risk of future misconduct, not addressable by mandates. Second, the federal agencies that are legally required to exclude firms convicted of specific felonies should be better off when prosecutors regularly use DPAs. Agencies can better achieve their goals when they have discretion to exclude a firm if, but only if, the agency determines that the firm presents a genuine risk of causing future harm to the agency’s interests that cannot be more efficiently addressed by other solutions, such as mandates—discretion which the agency retains after a DPA but not after a plea.

In summary, we conclude the potential for settlements to impose costs from reputational damage does not provide a deterrence-based justification for a policy favoring conviction over DPAs.8

The rest of this chapter proceeds as follows. Section 2 discusses the costs that may be directly imposed on firms by conviction and DPAs, and concludes there are no systematic differences between the two. Section 3 identifies the types of information released by a criminal settlement that may affect the cost to a corporation from reputational damage. Section 4 assesses the qualitative information released by guilty pleas and DPAs to determine whether pleas are likely to reveal more information indicating that the firm presents a heightened risk of future misconduct. Section 5 examines the responses of federal agencies acting as interested outsiders to evaluate whether, given the laws that constrain them, agencies are undermined in their ability to exclude corporations when they would prefer to do so by prosecutors’ use of DPAs. Section 6 concludes.

2. Formal Sanctions, Reforms and Mandates: Plea v. DPA

Critics of existing enforcement policy argue that DPAs undermine deterrence by

lowering the overall cost of the criminal sanction to the corporation (Uhlmann 2013; Garrett 2014). In this section, we consider the formal sanctions, reforms, and mandates that are revealed by the corporate criminal settlement agreement.9 We examine whether

8 Of course, federal enforcement policy could be reformed to target convictions at firms with enhanced risk of future misconduct, thereby providing a signal to interested outsiders. But there are other ways to provide this signal and such a policy would sacrifice other goals, such as inducing self-reporting and cooperation (Arlen 2012; Arlen and Kraakman 1997). A policy favoring conviction in most cases would be inconsistent this effort.

9 Firms adopt reforms voluntarily prior to the criminal settlement, and also as mandated by the settlement. Prior to and during settlement negotiations firms regularly undertake reforms. Prosecutors may discuss those reforms during the criminal settlement. In addition, the prosecutor and firm may agree to include some of the reforms that were proposed voluntarily as mandates. We accordingly discuss in this


prosecutors’ ability to impose these sanctions and mandates is more constrained when they settle through DPAs than pleas.

Costs that are imposed on companies directly through the criminal settlement arise from the exercise of discretion by prosecutors, and the ultimate bargain reached with the management of the firm (negotiated with the firm), in drafting three parts of the agreement. First, the criminal settlement can detail and require the firm to admit to the criminal misconduct. Second, it can impose criminal fines and other monetary sanctions. Finally, the agreement can require the firm to undertake costly reforms, including specific changes to the firm’s compliance program and a requirement that the firm accept a monitor. We find no differences between DPA and plea in these areas. Thus, the validity of the claim that DPAs necessarily impose lower costs on companies than pleas rests on whether the choice of settlement form alters the other, indirect costs to the company (see Section 3).

2.1. Admission of Wrongdoing

Corporate convictions generally result from negotiated plea agreements, and thus are reached without a trial or any other finding of guilt by an independent fact-finder. In a plea agreement, the prosecutor and the firm document the alleged misconduct and the firm admits to the wrongdoing. Discussion of corporate misconduct in criminal settlements contain three features: formal charges, a detailed statement of the facts of the crime, and a corporate admission of responsibility for criminal conduct. Usually the content of each is the product of a negotiation between the firm and the prosecutor, and is contained in a negotiated resolution.

DPAs have a similar structure. Prosecutors entering into DPAs file formal charges against the firm that are recounted in the DPA.10 The agreement includes a statement of the admitted facts of the crime that is negotiated between the prosecutor and the firm—a statement that could be used as evidence against the firm if the agreement is breached. As with a plea agreement, firms entering into DPAs generally expressly admit that they engaged in specific acts that violated the law.11 Thus, DPAs and plea agreements both typically include statements of facts that are negotiated in the shadow of the prosecutor’s threat of trial and that contain the firm’s admission of criminal wrongdoing.

With both plea agreements and DPAs, the information on charges filed and the contents of the agreement are publicly disclosed. Both agreements are filed in court. In addition, both types of agreements generally are available through the press releases issued by federal prosecutors, and are discussed (and available) through law firm client memos, blogs, and press coverage.

section reforms that firms announce at the time of settlement independently of their inclusion as formal mandates in the agreement.

10 NPAs are similar to DPAs except that formal charges are not filed with a court.

11 This is not a requirement of policy to our knowledge, yet we have found very few DPAs in which the firm did not admit to a violation of a criminal statute (and, thus, criminal wrongdoing). The point for our purposes is that prosecutors can and usually do structure DPAs to ensure that the firm admits to the misconduct.


2.2. Monetary Sanctions Prosecutors entering into corporate criminal settlements can impose monetary

sanctions that include fines and criminal restitution. The use of a DPA rather than a plea agreement does not change this. Prosecutors entering into DPAs can impose the full range of, and same magnitude of, monetary sanctions, including monetary sanctions that are delineated as “criminal fines.” As with guilty pleas, prosecutors’ ultimate authority to impose fines is governed by the statutory provisions that set forth the sanctions that may be imposed on a firm for the charged filed. Beyond this, DOJ policy encourages prosecutors to seek sanctions consistent with the Organizational Sentencing Guidelines where applicable, but prosecutors have discretion to recommend sentences that deviate from the Guidelines fine range in appropriate circumstances—for example to reward self-reporting. Thus, the use of a DPA does not appear to limit the prosecutors’ authority to impose monetary sanctions.12

Indeed, monetary sanctions in federal corporate criminal settlements are not generally lower under DPAs than pleas. In their study of criminal settlements involving public companies, Alexander and Cohen (2015) found that, between 2007-2011 the median monetary sanctions under DPAs were almost three times larger ($28.9 million) than under pleas ($10.6 million). They also find a greater frequency of DPAs involving parent corporations, as well as differences in the types of cases typically resolved through guilty pleas and settlements. For example, antitrust and environmental cases generally are resolved through guilty pleas whereas Foreign Corrupt Practices Act and Anti-fraud and Money Laundering charges against financial institutions tend to be settled through DPAs. All of this is consistent with the view that prosecutors have no less ability to impose monetary sanctions through DPAs than through guilty pleas.

2.3. Corporate Reforms and Mandates

In addition to the admission of wrongdoing and the monetary sanction, criminal settlement agreements provide information about both reforms that the firm has announced at the time of settlement, and reforms and undertakings that the firm is required to continue or implement in the future.13 We refer to them as reforms and mandates.

12 The possibility remains that differences in the influence of the judge could lead to differences in settlement outcomes between DPAs and pleas. With pleas, prosecutors negotiate the sanction that is set forth in the plea, but the judge has the final authority to determine the sentence. Judges have authority to alter recommended sanctions in either direction. U.S. v. Booker, 543 U.S. 245 (2005). By contrast, with DPAs prosecutors both negotiate and determine the sanction, subject to the constraint imposed by the firm’s ability to seek review by the DOJ (main justice) should the prosecutor abuse her discretion. DPAs are filed in court, but this judicial oversight authority does not appear to include authority to alter any lawful monetary sanctions imposed. U.S. v. Fokker Services, B.V., 818 F.3d 733 (D.C. Cir. 2016). 13 These are sometimes known as non-monetary sanctions. For example, see Khanna and Dickerson (2007), Alexander and Cohen (2015). Arlen and Kahan (2017) distinguish non-monetary sanctions from mandates because mandates, rather than sanctioning past conduct, create and impose a new legal duty that is enforced by the threat of future sanctions. Also, if mandates are used efficiently to reduce “policing agency costs,” as they propose, then an effective mandate could benefit the firm, rather than sanction it, by enabling it to more effectively deter future crime and possibly reduce the expected cost of reputational damage (see


Following detection of misconduct, firms regularly implement voluntary reforms to both ensure and convince outsiders that there is a low risk of future misconduct. For example, firms regularly reform their compliance programs and terminate employees implicated in the misconduct (Alexander 1999, Alexander and Cohen 2011, Alexander and Cohen 2015). Voluntary reforms are typically announced at settlement even though they were implemented previously. Corporate criminal settlements regularly mandate that certain reforms continue for the duration of the agreement (Arlen and Kahan 2017).

In addition, criminal settlement agreements usually require firms to implement reforms or undertakings beyond what has already taken place, such as additional compliance program reforms and hiring a monitor (see Greenblum 2005; Garrett 2007; Alexander and Cohen 2015; Arlen and Kahan 2017). Mandated reforms result from bargaining between the prosecutor and the firm. Mandated reforms can impose new duties on the firm (Arlen and Kahan 2017). These can include specific changes to the firm’s compliance program, changes to management or board oversight of compliance or particular business practices, the addition of independent directors, and a requirement that the firm hire a monitor acceptable to the prosecutor (Garrett 2007, 2014; Alexander and Cohen 2015; Arlen and Kahan 2017; see Khanna and Dickerson 2007).14 Both pleas and DPAs set forth the details of the mandates that are imposed.

These mandates are intended to, and may, improve the firm’s ability to deter misconduct in the future. But they also can impose significant direct costs on the firm—costs properly viewed as a cost imposed through the criminal settlement (Alexander 1999; Alexander and Cohen 2015; Arlen and Kahan 2017). For example, mandated compliance programs can be substantially more expensive than what firms would voluntarily adopt. Monitors also can impose substantial direct costs on firms in their efforts to improve the firm’s performance of its legal duties (Khanna and Dickerson 2007; Arlen and Kahan 2017; see Garrett 2007).

As with other costs imposed by prosecutors through criminal resolutions, prosecutors’ ability to impose mandates is not weakened by the choice to enter into a DPA instead of a plea. Prosecutors can impose the same range of reforms through either

infra Section 3.3).

14 A literature has emerged to provide empirical evidence and supporting theory regarding prosecutors’ use of criminal settlement agreements to impose new duties (i.e., mandates) on corporations. E.g., Garrett (2007); Arlen (2012); Garrett (2014), Alexander and Cohen (2015), and Arlen and Kahan (2017); see also Khanna and Dickerson (2007, analyzing monitors). Explanations of the economic role of voluntary reforms and/or mandates can be found in Alexander (1999, observing that voluntary reforms can serve as a form of reputational repair), Alexander and Cohen (1999, proposing a link between the governance structure of the firm and the occurrence of corporate crime), Khanna and Dickerson (2007, viewing monitors as a non-monetary sanction potentially justified by asset insufficiency), Alexander and Cohen (1999, 2015; voluntary and mandated reforms can reduce agency costs), and Arlen and Kahan (2017, voluntary and mandated reforms can be justified only when agency costs plague corporate “policing,” e.g., compliance, self-reporting, investigations, and cooperation).


agreement.15 In fact, prosecutors not only can, but usually do, impose mandates when entering into DPAs (Arlen and Kahan 2017). Prosecutors have in practice obtained more governance reforms and mandates through DPAs than through plea agreements, on average (Alexander and Cohen 2015).16 The frequent announcement of voluntary and mandated reforms at the time of both DPA and plea settlements is apparent in trends from public company data after the 2003 Thompson memo, as shown in Table One.17 Further, the use of a DPA does not appear to limit the ability of the prosecutor to impose other constraints, such as restricting the ability of a firm to enter into certain lines of business. Firms also have terminated managers responsible for the wrong—including senior managers—in the course of entering into both types of agreements (Alexander and Cohen 2015 discussing DPAs and plea agreements; see Arlen and Kahan 2017, discussing DPAs; see also Alexander 1999, discussing plea agreements).

Insert Table One here

2.4 Summary

Thus, the decision to resolve a corporate criminal investigation through a DPA instead of a plea agreement does not limit the ability of the prosecutor to impose costs directly on the corporations through the settlement. Prosecutors are able to obtain admissions of wrongdoing, impose monetary sanctions, and obtain reforms and mandates

15 There are some procedural differences. The USAM contains provisions governing monitors imposed through DPAs and NPAs that are designed to enhance oversight by main justice and limit opportunities for cronyism. USAM, §§ 163, 166. In addition, mandates imposed through pleas are subject to judicial review whereas the D.C. Circuit concluded that those imposed through DPAs are not (unless they are unconstitutional). U.S. v. Fokker Services, B.V., No. 15-3016, D.C. Circuit (April 5, 2016). The attention accorded to one judge’s decision to modify a monitor imposed by a plea to give him oversight over the monitor suggests that it is unusual for a judge to alter the terms of such a mandate. See Andrew Levine, et al. Judicial Scrutiny of Corporate Monitors: Additional Uncertainty for FCPA Settlements?, Compliance and Enforcement (June 22, 2017), discussing United States v. Teva Pharmaceutical Industries Ltd., Deferred Prosecution Agreement, No. Cr. 20968 FAM (S.D. Fla. Dec. 22, 2016) https://wp.nyu.edu/ compliance_enforcement/2017/06/22/judicial-scrutiny-of-corporate-monitors-additional-uncertainty-for-fcpa-settlements/ 16 Prosecutors have included more than twice the number of governance reform mandates in DPAs than in plea agreements, post-2003, on average. The number of governance reform mandates per agreement in 2007-2011 was 3.4 for DPAs and 1.3 for plea agreements for public company settlements in that period, both numbers higher than in 2003-2006. See Alexander and Cohen 2015 at 590. Differences in mandates also may result from differences in in case type (e.g., antitrust versus FCPA), practice area (environmental division versus Fraud section), and offender type that are correlated with the use of DPAs and pleas. 17 The empirical evidence in Table One is from a sample of settlement agreements collected for the Alexander and Cohen (2015) study that compared the use of pleas and DPAs to settle criminal investigations of public companies before and after the 2003 Thompson memo. The signatory of each settlement agreement was the DOJ (or USAO) and a public company. Evidence of reforms and mandates were obtained from settlement documents and press statements from the settlement period. Other researchers have obtained different results by altering the sample selection method, delineating the reforms differently, or by limiting attention only to reforms that are mandated or discussed in the settlement agreement (e.g., Garrett 2014, Arlen and Kahan 2017).


through a DPA as well as through a plea. Prosecutors thus have access to all of the forms of sanction that are available to them when negotiating plea agreements when they settle through a DPA.

Differences in the overall costs of the settlement nevertheless could arise from differences in the reactions of interested outsiders to the two forms of settlement. Criminal settlements can directly or indirectly release information bearing on the expected future costs to interested outsiders of dealing with the firm in the future; this may cause interested outsiders to respond in ways that impose costs on the firm. This cost from reputational damage is a cost of a criminal settlement, as we discuss in the next section.

Critics of DPAs claim that DPAs produce lower costs of reputational damage, thereby weakening the general deterrent effect of the settlement (e.g., Uhlmann 2013; Garrett 2014). The rest of this chapter considers in depth whether there is a basis for the view that settlement through a DPA affects the company’s cost from reputational damage relative to what would occur if the company settled the same charges, with the same sanctions and reforms, through a plea agreement. Section 3 explains how criminal settlements can affect the cost of reputational damage to the firm by influencing the reactions of interested outsiders. Section 4 explores whether the decision to settle through a DPA instead of a plea affects this cost through its effects on the information released or signaled to interested outsiders about their expected costs of dealing with the firm in the future. In Section 5, we consider the role of the government agency as an interested outsider, focusing on agencies whose discretion is constrained by laws on exclusion and delicensing. We assess whether DPAs undermine federal agencies’ ability to employ exclusion and debarment to protect their interests.

3. Cost of Reputational Damage: Outsider Reaction to the Settlement

In this section, we consider how the qualitative information that is contained in and released by a criminal settlement agreement can affect the cost from reputational damage or stigma to the company from the settlement.18

Firms sustain costs from what we regard as reputational damage or stigma when they enter into a criminal settlement that leads outsiders who would otherwise deal with the firm in the future to be less willing to do so (hereinafter interested outsiders). In this section, we identify the types of information released by a criminal settlement that may affect interested outsiders’ willingness to deal with the firm using a framework that we provide for this purpose. The first two parts explain that criminal settlements can result in firms’ expecting to incur costs, imposed from outside the legal system, as a result of the anticipated reactions of outsiders to the information released by the settlement. The next part discusses the basic information about offense type released by the criminal settlement

18 As explained in Section 2, the prosecutor and firm release information relating to the settlement in various formats over a period of time that leads up to and includes the formal date of the settlement. For simplicity, we refer to the information that would not be released but for the settlement in this section as the information that is released “by” the settlement.


that is, or is not, likely to lead interested outsiders to be less willing to deal with the firm. The fourth part discusses the potential effects of information released by the criminal settlement about the offender that could enhance or mitigate interested outsiders’ expectation about the future risks of dealing with the firm. This includes information about the corporation’s relation to the offense (e.g., the scope of the offense, managerial involvement, location of the offense, and internal governance). Offender characteristics include reforms undertaken by the firm or required by the agreement designed to deter future misconduct. The appendix to this chapter illustrates these points using a formal model that indicates ways in which the release of information through a settlement agreement can influence outsider reactions and thus the cost of reputational damage to the firm.

In sum, criminal settlement agreements contain and lead to the dissemination of qualitative information about the offense, the offender’s relation to it, and reforms or mandates that can influence outsiders’ reaction to the criminal misconduct and, thus, the cost of reputational damage to the firm. Even when the firm’s misconduct was publicly disclosed, a criminal settlement can alter—and potentially increase (or decrease)—the cost to the firm from the reputational damage relating to the offense.

3.1 How Interested Outsiders’ Expectations Determine the Cost of Reputational Damage

The expected cost to a firm of reputational damage following a criminal settlement depends on the degree to which the settlement causes the release of information that leads interested outsiders to expect a heightened risk harm to them through future misconduct. Thus, unlike the formal legal sanction, the cost from reputational damage is not directly imposed by prosecutors. It is imposed by the “market” or, more specifically, by the reaction of outsiders who could have been expected to deal with the firm in the future and whose self-interested reaction to a negative signal can impose costs on the firm.19 We refer to these outsiders as “interested outsiders.” They may include prospective customers and clients, suppliers, and government agency payees.20 It is the voluntary nature of their dealings with the firm that empowers interested outsiders to react to the criminal settlement, and to do so in a manner that can be costly for the firm (see, e.g., Darby and Karni 1973).21

19 For a formal model, see the Appendix to this Chapter. A central insight of the economics literature on alternatives to legal rules as a source of discipline on firms is that outsiders can impose a future cost on the firm through their reactions to the firm’s failure to provide services of anticipated (high) quality. For early examples, see Darby and Karni (1973), Darby (1975), Dybvig and Spatt (1983, 1985); Klein and Leffler (1981), Shapiro (1983); see also Tirole (1988 at 123 provides a survey). 20 See infra Section 5 (discussing government agencies as interested outsiders). The position of the interested outsider in relation to the offender is similar to the that of the related party in Alexander (1999) and trading partner in Iacobucci (2014), in which the cost of reputational loss to the firm arises because “observers have changed their views about the benefits of dealing with the offender that has revealed by its wrong its type as one that is unattractive to trading partners with trading conceived broadly” (Iacobucci 2014, at 190).

21 A related literature examines the link between formal sanctions and the cost to the defendant of a


Several basic factors must be present for the information revealed by the settlement to cause outsiders to react in a way that imposes costs on the firm from reputational damage. First, the settlement information must lead the outsiders to update their views about their future risk of harm from doing business with the firm.22 The information revealed by the criminal settlement might indicate that a future offense is more likely to occur or would be more harmful to the outsider than previously anticipated. The outsider might also face higher costs of precautions to avoid such harm. The point is that the information provided through the settlement must lead the outsider to anticipate a greater cost, or lower gain (greater risk of loss) from dealing with the firm in the future than previously expected.23

Second, the interested outsider must be willing and able to respond to the increased risk of loss from future dealings with the firm by taking his business elsewhere. This could involve avoiding dealing with the firm entirely or in part, such as by diverting some or all transaction volume to one of the firm’s competitors.24

Third, the anticipated outsider reaction must be costly to the firm. The future business that outsiders take elsewhere must be of value; the firm cannot be indifferent to its loss. The firm may attempt to avoid this cost by making concessions or undertaking reforms to prevent the loss of outsider business. The cost of such concessions or undertakings is a cost from reputational damage where it arises from the prospect of lost future business beyond what the firm would otherwise face. Thus, the aggregate cost from reputational damage is a combination of the cost of lost business and the cost of reforms and concessions to avoid such loss (e.g. a better price or evidence of commitment to reforms that eliminate the risk or investment to enhance quality).

Insert Figure One here

3.2. Impact of a Criminal Settlement on the Cost of Reputational Damage

Firms that commit crimes that harm outsiders, such as fraud, may incur costs from reputational damage whether or not the government ever brings criminal charges. Indeed, the early scholarly analyses of reputational damage costs examined how firms could be deterred from committing fraud by the expectation that some customers would discover

formal conviction. For example, Daughety and Reinganum (2015) assume a greater outsider reaction to conviction than to plea, and explore the effects on the plea outcome. In considering informally the choice between plea and DPA, we allow the outsider’s reaction to vary with the information revealed by the settlement.

22 Harm takes the form of ex post regret about choice of counterparty in this setting, evaluated from the individual outsider’s perspective.

23 See infra note 28. 24 To deter misconduct, it is sufficient for the seller to anticipate an outsider response (regardless whether the response actually occurs). In considering alternative outsider responses and their effect on the cost of reputational damage in this chapter, we take the perspective of the firm and limit attention in this chapter to those responses that a firm would plausibly anticipate at some future settlement.


the fraud on their own and react by refusing to deal with the firm in the future and possibly spreading the information to other customers, who might respond similarly (Darby and Karni 1973). Nevertheless, several considerations can limit the deterrent effect of this response. The first is the quality of information reaching outsiders about the existence of and causes of any harms suffered as a result of corporate misconduct. Parties dealing with the firm sometimes cannot reliably determine that they were injured, whether their injury was attributable to corporate misconduct, such as fraud (Darby and Karni 1973), and whether the conditions that led to the fraud are likely to persist. Second, individual discoveries of corporate misconduct may not be broadly disseminated to all current and future interested outsiders who might beneficially respond to this information.

Corporate criminal settlements can affect the expected reputational damage costs to firms of corporate misconduct by improving both the quality and accessibility of the information that reaches interested outsiders.25 Criminal settlements can provide more precise information to outsiders about the nature and extent of the harm from the misconduct. They also potentially can improve the quality of outsiders’ information about the offending firm’s relation to the offense. Criminal settlements also can affect the cost of reputational damage by disseminating information about the misconduct more widely, both in the U.S. and abroad.26

In addition to releasing information about the crime, criminal settlements can impact interested outsiders’ expectations by releasing information about reforms undertaken by the firm post-crime. For example, they can include provisions that enhance the transparency of voluntary reforms undertaken by the firm to avoid future misconduct. They may relatedly mandate reforms designed to influence the outsider response by altering the firm’s future risk of misconduct.27

The next parts explore when and how the information released by criminal settlements about the offense, the offender, and future undertakings may affect outsiders’ expectations in a way that causes the firm to incur costs from reputational damage.

3.3 Offense type and the Interested Outsider

In evaluating news of the settlement, interested outsiders have access to the government's press release announcing the criminal resolution, the content of the criminal settlement itself, and press coverage of the criminal settlement. These sources provide interested outsiders with information about the crime—the facts of the offense, the charges filed, and the sanctions imposed. This information about the offense may, but need not, lead them to be unwilling or less willing to deal with the firm going forward.

25 See infra the Appendix. 26 This increased access can occur both through the public press release announcing the settlement and through press coverage of the criminal settlement.

27 See infra Section 3.4.2.


Interested outsiders voluntarily divert transactions away from a firm with admitted wrongdoing when it is in their self-interest to do so.28 News that the firm admitted to a crime that harmed some interested outsiders can cause other, similarly situated outsiders not to want to deal with it in the future.29 The canonical case is conviction for actions that injure a corporation’s customers.30 The rational self-interested reaction of potential future customers to news of such a conviction would be to limit their future dealings with the firm in order to limit their risks of being harmed by a future offense. Specifically, they may take their business elsewhere, reduce their willingness to pay, or insist on additional oversight or guarantees, depending on their access to alternative sources of supply and thus private cost of doing so.31 This assumes the news of the offense signals a heightened risk of harm from future misconduct. It also assumes the customer can avoid the harm by taking her business elsewhere. If this last assumption is violated, however, interested outsiders would have no reason, based on news of the misconduct itself, to alter their future dealings with the firm because going elsewhere would not change their future risk of harm. Consequently, they would have no reason to be less willing to deal with the firm in the future, notwithstanding the criminal settlement.32

To illustrate, consider three different types of crimes: fraud, environmental crimes that harm those in the vicinity of the firm’s operations, and illegal price-fixing agreements by all the firms in an industry.

28 Indeed, interested outsiders arguably change their plans for dealing with the firm in the future only when the news of the conviction reduces their expectations about the net benefits of future purchase from, or relationships with, the firm. A criminal settlement can alter interested outsiders’ expected benefit of dealing with the firm by causing them to expect a higher risk of harm from future misconduct by the firm.

Of course, in retail markets, consumers sometimes react to misconduct that does not expressly harm them. For example, those consumers could experience disutility from corporate misconduct involving violations of child labor laws if, upon learning of the violation, they would feel responsible for illegal or inhumane conditions in the factories producing the goods they purchase. As a result, they may be less willing to purchase goods from a firm convicted of such practices if they anticipate such misconduct could happen in the future.

In addition, it is possible that some people may have social-regarding preferences that causes them to eschew all dealings with all convicted corporations in the belief the firm has violated the social compact, even when they otherwise would obtain a material benefit from dealing with the firm. Yet many people behave as though they focus primarily on their own interests, and tend to make decisions based on the expected value of their purchases and business relationships to themselves. 29 In addition, the criminal settlement may reveal facts about the firm’s internal governance and/or reforms undertaken by the firm that affect the outsider response. We discuss this in Section 3.3 infra. See also note 32 supra (discussing other types of future expected costs).

30 Direct dealings are also absent from money laundering, as noted in Iacobucci (2014 at 192) and Alexander (1999; money laundering as a third-party offense).

31 A firm may harm counter-parties indirectly by committing the type of malum in se offense in the production of the goods that could cause those purchasing from the firm to experience disutility from purchasing a good (and thus increasing the demand for a good) whose production resulted in illegal and immoral acts (such as extreme labor violations). See supra note 28.

32 See supra note 28.


Fraud. A firm convicted of defrauding a subset of customers may face costs of reputational damage because fraud typically implicates all three factors discussed above. First, potential customers contemplating future dealings with the firm may view news that the firm defrauded similarly situated customers as a signal that they face a greater risk of being defrauded by this firm than previously believed. Second, those customers may rationally respond by taking that business elsewhere or requiring concessions from the firm to compensate for the higher risk of harm from future frauds.

Environmental crime. In contrast, a firm that enters into a criminal settlement for an environmental crime that harms people living in the vicinity of the firm’s operations is unlikely to incur costs from reputational damage. News of the settlements may signal that the firm is more at risk of causing environmental harm in the future. Yet the harm from this type of environmental offense does not fall on people who purchase from or sell to the firm. Those interested outsiders, in contemplating future dealings with the firm, are unlikely to conclude based on news of the crime that a decision to deal with the firm would expose them to an increased risk of future harm.33 As a result, they would likely continue to deal with the firm as before. The offending corporation should not incur costs from reputational damage from this type of offense (Jones and Rubin 2001; see also Karpoff and Lott 1993, Lott 1996, Alexander 1999, Karpoff, Lott, and Wehrly 2005; but see Cohen 1992).34

Antitrust (collusive price-fixing and bid-rigging). News that a group of firms entered into a criminal settlement for colluding to fix prices or rig bids may signal interested outsiders that they face an increased risk of future harm from dealing with the offending firm. Nevertheless, the firms involved may not incur substantial costs from reputational damage because their customers may be unable to avoiding future dealings with the offending firms to the extent that all firms in the industry – all suppliers of a good or service – are involved in the offense. Thus, the second factor is not fully implicated because customers who cannot turn to substitute unimplicated suppliers may prefer to stick

33 We recognize that monetary sanctions can cause a firm to face financial distress that can create moral hazard problems that introduce a risk of a future offense. It appears unlikely that differences in the form of settlement would create any differences in the effects of the monetary sanction on the cost that firms face through this channel, however.

34 The essential point is that it is difficult for victims of environmental crimes to avoid the harm by choosing (individually) not to deal with the offending firm, even with advance knowledge of the misconduct. An environmental conviction could produce a reputational penalty if, as Mark Cohen suggests, news that a firm knowingly discharged waste or falsified evidence of environmental wrongdoing adversely affects customers’ perceptions about the quality of the firm’s products (Cohen 1992). This effect appears unlikely when the perceived link between the firm’s misconduct and the value to consumers of the firm’s products is tenuous.

In addition, some infamous environmental crimes could produce a cost of reputational damage to the extent that customers conclude that the firm’s conduct was reprehensible and thus the firm no longer deserves their business. The empirical evidence suggesting no reputational damage for environmental harms (Jones and Rubin 2001, Alexander 1999, Karpoff, Lott and Wehrly 2005) indicates that firms tend not to sustain material losses from this kind of customer response.


with the convicted supplier rather than incur costs of switching to another product or withdrawing from the market altogether. For this reason, the cost from reputational damage to the offending firms often will not be high for offenses involving collusive behavior, such as price-fixing. This underscores the importance of ascertaining interested outsiders’ ability to reduce expected harm by avoiding dealing with the offender when assessing the expected cost to the firm from reputational damage. For offenses that implicate all firms in an industry, the cost from reputational damage is likely to be lower than if the offense involves only one of the firms.

3.4. Aggravation and Mitigation of the Outsider Response

Criminal settlement documents generally contain information about the corporation’s relation to the offense that may affect interested outsider’s assessment of their likelihood of future harm from dealing with the firm.

Outsiders assessing the probability of being harmed by future misconduct may take into account the prosecutor’s determination of whether the firm’s compliance program was effective,35 as well as the discussion (or lack of discussion) of specific deficiencies in the compliance program. In addition, they may consider information in the criminal settlement about whether the crime was committed by individuals who remain at the firm, committed or condoned by senior managers, involved many employees and many divisions across the firm, persisted undetected over a long period of time, or was rewarded by the firm’s compensation or promotion policies.36 In addition, outsiders may treat as red flags evidence that the firm detected misconduct but failed to address initial red flags brought to management’s attention; conducted an inadequate or obstructive investigation, that, for example, resulted in the prosecutor requiring the firm to have a monitor; and maintained a management team with senior management willing to accept a risk of harm to interested outsiders. In addition, depending on the circumstances, some observers might interpret evidence that the crime involved only one, low-level employee; or that the firm promptly detected and put a halt to the crime as indicating a low risk of a repeat offense.

We refer to conditions that, if present, would amplify the outsider reaction to the

35 Interested outsiders’ reactions to statements in the criminal settlement document that the firm’s compliance program was or was not effective may be influenced by their views on the prosecutor’s ability to identify an effective compliance program, as well as by statements about specific deficiencies and the scope and duration of the misconduct.

36 Corporate crime can be a direct or indirect result of management’s exercise of influence in the firm. Misconduct arising from misalignment between the incentives of management and the incentives of outside shareholders is an agency cost of the firm (Macey 1991; Arlen and Carney 1992; Arlen 1994; Arlen and Kraakman 1997; Alexander and Cohen 1992, 1999; Burns and Kedia 2006; Bergstresser and Philippon 2006; and Efendi, Srivastava, and Swanson 2007). Misalignment may occur through promotion or job-security incentives and through compensation packages. News of a conviction can signal that the firm’s compensation and promotion system provides incentives to pursue risky strategies that provide short term benefits, including intentional crime (Arlen and Kraakman 1997), and that its internal governance and compliance does not fully deter wrongdoing (see Beasley (1996), Agrawal and Chadha (2005).


offense and thus increase the cost from reputational damage to the firm as aggravating factors. Offender characteristics that an outsider would associate with a relatively low risk of harm from a future offense are here termed mitigating factors.37

Whether any of the information about the offender in relation to the offense affects the outsider reaction and thus the cost from reputational damage depends on whether it is new information (not already known by the outsiders) and credibly signals a difference in the risks relating to a further offense from the outsider perspective. This is relative to the reaction that would occur in the absence of such offender-specific information. Thus, detailed information about the offender in relation to the offense can have an aggravating or mitigating effect on the cost to the firm, depending on the context.

We have found that settlement agreements often indicate how many separate departments, divisions or subsidiaries of the firm were involved in misconduct, how many different offenses were committed, and the duration of the offenses. Information released at the time of settlement may further reveal that management ordered or condoned the crime, or that the firm had (and has) a compensation system that appears to have incentivized the misconduct. Offense-date-specific information may alternatively suggest that a future offense by the same firm is unlikely to occur. Such a crime might be said to originate from the actions of “a single rogue employee.”38 This information may inform the outsider reaction to the settlement.

3.4.1. Information on the Relation of Offender to Offense

In the United States a corporation can be convicted for misconduct of an individual employee, including a low-level employee, committed in the scope of his employment and with intent to benefit the company. Thus, outsiders seeking to determine the involvement of others in the firm in evaluating their risk of harm from a future offense can be expected to seek information about the corporation’s relationship to the offense. This information may reveal whether the crime is attributable solely to an isolated individual, or is partly attributable to features of the firm that could cause or allow others to violate the law in the future.

First, some observers may find it useful to consider the detailed statements of facts about the crime set forth in the criminal settlement document for information about a variety of factors about the crime that bear on the likelihood of future misconduct. For example, criminal settlement agreements often reveal facts bearing on whether the crime

37 We use the terms aggravating and mitigating factors to refer to considerations that can differ from those deemed aggravating and mitigating factors by the U.S. Sentencing Guidelines Governing Organizations.

38 On crime as an agency problem of the firm that arises from individual employee’s pursuit of private benefits see Macey (1991), Arlen (1994), see also Arlen and Carney (1992). For theory and evidence on crime as a principal-agent problem of the modern corporation, in which management faces a tradeoff between private benefits and costs of actions to prevent criminal acts by lower-level employees, see Alexander and Cohen (1992, 1999).


was an isolated event or part of a pattern of events.39 These include information about how many separate offices were involved, how many different offices were involved, and the duration of the offenses. Information released at the time of settlement may further reveal that management ordered or condoned the crime, or that the firm had (and has) a compensation system that appears to have incentivized the misconduct. In addition, media attention to the specific individuals blamed for the misconduct of the corporation may affect interested outsiders’ beliefs about the expected harm from dealing with the firm, depending in part on the seniority of the people involved and whether the news coverage indicates that those individuals have remained with the firm.

In addition to revealing information about the crime, criminal settlements also can reveal information about features of the corporation’s internal operations potentially relevant to interested outsiders’ assessment of the risk of future harm from either the type of offense that occurred or other offenses. As previously noted, criminal settlement documents often reveal information about the overall effectiveness of the firm’s compliance program (Alexander 1999; see also Laufer 1999), including specific deficiencies (Arlen and Kahan 2017). The criminal settlement also may contain information about the firm’s culture (Tyler, Simpson), tone at the top and incentives of top management and employees (Arlen and Kraakman 1997; Alexander and Cohen 2011; Langevoort 2016), along with its ownership and board governance (Alexander and Cohen 1999, Arlen and Kahan 2017). It also may reveal that the firm might have instituted compensation and promotion policies that create pressure to violate (or comply) with the law (see Arlen and Kraakman 1997). This information may be relevant to interested outsider’s expected risk of dealing with this firm.

Outsiders’ expectations also can be affected by information about the firm’s response to news of the misconduct. Firms can deter crime through a credible policy favoring in-depth investigation, self-reporting, and cooperation that provides evidence about the individuals responsible for the crime as these activities should increase employees' expected cost of crime (Arlen and Kraakman 1997). Internal governance that promotes such "policing" activities may thus reduce agency costs, thereby reducing misconduct in general.

Finally, when the firm does not appear to be plagued by misconduct in all its operations, interested outsiders may consider the specific location of the crime in the firm in assessing their own expected cost of dealing with the firm. Criminal settlements regularly identify specific divisions, subsidiaries, or offices as being responsible for the misconduct. This may lead interested outsiders to regard the risk of a future offense to be

39 In addition to the internal conditions of the firm, external conditions can directly and indirectly affect the occurrence of crime. We focus on internal conditions as these are most likely to become known by the criminal settlement, and thus are the most promising potential source of a differential impact of pleas and DPAs.


lower if the central nexus of their dealings with the firm lies elsewhere.40 Such an outsider might, for example, react differently to information indicating that the crime was entirely attributable to the firm’s Nigerian operations if the outsiders’ future dealings are likely to be distant from the Nigerian operations of the company than to information that misconduct occurred in the division with which the outsider is likely to deal in the future.41 Similarly, an interested outsider who purchases jet engines from a firm might respond differently to a corporate criminal settlement for fraud harming customers if information released by the criminal settlement reveals the fraud involved the jet engine division than if it involved a separate health care division.

Interested outsiders who treat these considerations as material to their assessment of the future risk of harm when dealing with a firm sanctioned for committing a particular offense may respond differently to two firms sanctioned for the same offense (of the same magnitude) depending on the information provided in the criminal settlement document about these aggravating and mitigating factors.

3.4.2. Mitigation through Offender Reforms and Mandates

Interested outsiders’ expected costs depend on the risk of harm from the firm in the future, and not at the time of the offense. Criminal settlements can both reveal and cause a difference between the risk of misconduct at the time of the crime and the risk to outsiders when dealing with the firm in the future.

Criminal investigations and corporate criminal settlement negotiations can take many years to conclude. During this time, the risks of future misconduct may change as a result of voluntary reforms (Alexander 1999) as well as mandates imposed by prosecutors and regulators (Alexander and Cohen 2015, Arlen and Kahan 2017). Settlement documents often contain detailed information about reforms and mandates that an outsider might interpret as signaling a higher or lower chance of a repeat offense, depending on what is promised and the appraisal of its likely effectiveness.42 It is reasonable to consider reforms

40 Indeed, most large organizations are complex multi-faceted institutions composed of numerous offices or divisions that may be quite independent of each other. It does not automatically follow from news that an "organization" committed a crime that the areas of the firm of interest to a given outsider present an enhanced risk of future misconduct.

41 Media coverage depends in part on the information released through the settlement document. We thus recognize that the content of the settlement agreement can influence the extent to which media attention and blame attached to a specific individual or entity within the company. This can lead to differences in the reactions of interested outsiders. See section 4.1 for further discussion of the potential for differential media attention to result from criminal settlement through a plea instead of a DPA.

42 Criminal settlements separately present information about both the effectiveness of the firm’s compliance program leading up to the crime and reforms initiated between the crime and settlement. These reforms can cause the firm's risk of future misconduct to change in between when the crime occurred and the settlement. In addition, firms with detected misconduct may undergo a change of control in between the time the crime was detected and the criminal settlement. This also may alter the expected risk of future misconduct (Arlen and Kahan 2017).


and mandates among the mitigating factors that an outsider might consider in reaction to the offense.43

Of particular importance, many, if not most criminal settlements include prosecutor-mandated changes to the firm’s compliance program (Garrett 2007, Alexander and Cohen 2011, Arlen 2012a, Alexander and Cohen 2015, Arlen and Kahan 2017).44 Prosecutors often mandate that the firm maintain specific voluntarily-adopted compliance program reforms. In addition, they regularly impose new duties on the firm designed to deter future misconduct (Arlen and Kahan 2017). These mandates include requirements that the firm implement specific changes to its compliance program, adopt new management committees, and enhance oversight over particular types of contracts. The firm may agree to comply with agreements with regulators subjecting the firm to enhanced oversight and internal reforms (e.g., Corporate Integrity Agreements) (Alexander and Cohen 2015; Arlen and Kahan 2017).

Settlement agreements also may impose mandates to provide enhanced independent oversight over the firm’s efforts to comply with the law. Some mandates enhance oversight by internal parties, such as independent directors and specialized management committees. Other mandates provide for enhanced external oversight of the firm’s efforts to comply with the law. These include provisions in many settlement agreements that compel the firm to incur the costs of appointing and maintaining an external monitor or facing scrutiny from a regulator beyond what would occur otherwise (Khanna and Dickerson 2007, Alexander and Cohen 2015, Arlen and Kahan 2017). Elsewhere we refer to mandates that may enhance management's prevention effort or policing activities as “internal governance reforms” (Alexander and Cohen 2015) and “meta-policing mandates” (Arlen and Kahan 2017), respectively.

In summary, effective reforms can fundamentally change the cost to the firm of any reputational damage or stigma that it might sustain under either conviction or a DPA. While reforms can be costly to the firm (properly viewed as a cost of reputational damage), when sufficiently effective they can reduce outsiders’ negative reaction and thus the (net) cost of the criminal settlement. As a result, in principle, a firm sanctioned for a serious crime could experience little cost from reputational damage if it were able to mute any negative signal triggered by the settlement by implementing low-cost reforms that interested outsiders expect to be effective at deterring future harms.

43 The offender characteristics that we discuss in this section reflect our appraisal of candidate factors that an outsider might plausibly consider in evaluating the prospect of a future offense, conditional on settlement. The list may be over-inclusive and is offered to inform our analysis in the next section of the different channels through which a difference in form of settlement might lead to a difference in the cost of reputational damage to the firm. The question of what offender characteristics are in practice the best predictors of a firm being charged with a future offense is accordingly beyond the scope of this chapter and left for consideration elsewhere.

44 The practice of announcing reforms and mandates around settlement pre-dates the Sentencing Guidelines (Alexander 1999).


3.5 Summary

As we have seen, corporate criminal settlement does not automatically cause the firm to incur costs from reputational damage relating to the offense. Instead, the cost of this form of stigma depends on the type of crime and whether it can plausibly trigger such costs. Crimes such as procurement fraud, health care fraud, and other crimes involving harm to outsiders who are engaged in voluntary dealings with the offending firm are among the most plausible candidates. Environmental crimes are not.

In addition to these basic considerations, the costs of reputational damage from the settlement may vary according to the presence of aggravating and mitigating factors that can influence each interested outsider’s assessment of the future risk of harm to the outsider from the firm. These include the nexus between the crime and interested outsiders, as shown in Figure Two. They also include information about the firm’s internal governance, including information about any governance reforms or mandates that may be imposed by, or contemporaneously with, the criminal settlement.

Insert Figure Two here

4. Reputational Consequences of Conviction versus DPA

In this Section, we consider whether criminal settlement through a guilty plea instead of a DPA is likely to affect the cost to the firm from reputational damage by affecting its effect on the information that revealed to interested outsiders about their expected costs of dealing with the firm in the future (“risk of future harm”). Specifically, we evaluate whether any part of the process of resolving a criminal investigation through a plea instead of a DPA, in and of itself signals the firm has a higher risk of future misconduct, aside from the information expressly released in the agreement. We focus on the choice between a DPA and a guilty plea because corporate convictions are typically obtained through plea rather than going to trial. 45 For this purpose, we extend the framework that we introduced in section three and evaluate how the choice of settlement form could affect the cost to the firm arising of reputational damage from the settlement. We identify several candidate hypotheses regarding the effect of the selection of a DPA rather than a plea on the outsider reaction and thus the cost to the firm.

Interested outsiders would be less willing to deal with the firm going forward when the firm pleads guilty in this context only if the use of a plea, instead of a DPA, signals hidden information about the risk of future harm beyond the information directly revealed in the settlement document or enhances the weight given to the information about risk that was included in the settlement.46 There is otherwise no reason to react differently based on

45 See, e.g., Chapter Eight Organizational Sentencing Components, Interactive Sourcebook of Federal Sentencing Statistics, U.S. Sentencing Commission (July 2016), at Table 53 (reporting that almost 97.7% (2.3%) of the 132 organizations sentenced in FY 2016 under the Guidelines pled guilty and thus avoided a trial. Similar figures are found in earlier years.

46 Before considering these three channels it is important to note that a variety of cases can be excluded


the form of the settlement alone. We identify three candidate hypotheses about the channel through which the DPA-plea choice could affect the information that interested outsiders’ receive about the firm’s future risk of harm. Under the direct revelation hypothesis, the use of a plea is assumed to provide more reliable or salient information about the corporation’s misconduct. 47 The prosecutorial selection hypothesis posits that prosecutors require resolution through a plea, instead of a DPA, when they observe information—not fully revealed in the agreement—that the firm presents an enhanced risk of future harm. Finally, under the managerial selection hypothesis, pleas are assumed to provide a negative signal that managers accepted a plea agreement in order to avoid being held individually culpable and face individual sanctions for the misconduct.

We compare the information that outsiders receive under each of these hypotheses, based on both institutional analysis of how criminal settlements are negotiated and released and analysis of the specific considerations likely to be most important to a rational prosecutors’ office, assuming prosecutors are seeking to resolve the case, with appropriate sanctions, without incurring unnecessary costs.48 We find no reason to conclude that pleas convey more or stronger information that the firm presents a heightened risk of future misconduct than DPAs, holding constant the charges, identity of the firm, facts of the crime, voluntary reforms, and mandates imposed. We accordingly conclude that the use of a plea instead of a DPA is not likely to provide hidden information to interested outsiders about the expected cost of dealing with the firm through any of these channels and thus should not affect the cost to the firm from reputational damage following a criminal settlement.

4.1. Direct Revelation: Weighted Accorded to Information Released at Settlement?

As explained in Section 2, the criminal settlement agreements and associated press releases for pleas and DPAs can contain the same information about charges, misconduct, and other the candidate factors that may indicate to interested outsiders that they face an unexpectedly high future cost49 of dealing with the firm, as discussed in Section 3. In this

from consideration right from the outset. In particular, we would not expect the information about the form of settlement to matter if the firm is convicted of the types of crime that do not plausibly signal that interested outsiders face an increased risk of harm in dealing with the firm. For example, many environmental crimes that harm third parties and regulatory violations that do not harm counter parties are unlikely to produce material reputational damage costs regardless of the form of settlement. We exclude such cases from the discussion below.

47 Although we consider three channels, only one, direct revelation, could support a policy favoring conviction of almost all firms with detected misconduct, as apparently favored by some scholars (see Uhlmann 2013). The other two channels require that prosecutors reserve pleas for firms with enhanced risk of future misconduct.

48 We expect prosecutors to be particularly focused on the impact of pleas on the costs of the criminal settlement because, as shown in Section 2 supra, the choice between plea or DPA does not have a direct affect on the content of the settlement agreement.

49 Throughout this article, “cost” refers to opportunity cost and is not limited to costs that are out of pocket or readily quantified, unless otherwise indicated.


part, we consider whether interested outsiders nevertheless might assign greater weight to such information if it is released through a plea than DPA.50 We consider two possible reasons why this could occur– reliability and salience.

4.1.1. Reliability of Settlement Documents and Press Releases

First, we consider the possibility that the interested outsider might regard guilty pleas as providing more reliable information about the statements of the firm’s misconduct than DPAs.51

Statements in DPAs about charges, the facts of the crime, the firm’s internal governance, and other matters are the product of negotiations between prosecutors and the corporation and are not subject to independent review. Accordingly, a conviction could produce more reliable information if prosecutors seeking to convict took the extra step to establish the facts of the crime beyond a reasonable doubt through evidence submitted by both parties to an independent decision-maker. Yet this not the case. Corporate convictions are almost always obtained through guilty pleas negotiated by the parties in the shadow of the cost and risk to both sides of going to trial. In addition, although judges must approve both DPAs and plea agreements, judges do not make independent findings about the facts of the case in either context. Thus, both criminal pleas and DPAs involve statements of facts, charges, and sanctions that are negotiated by the prosecutor and the corporation.52 In neither situation are the facts of the crime proven or validated by an external arbiter such as a judge or jury.

In addition, pleas could provide more reliable evidence of guilt if the DOJ instructed or encouraged prosecutors to use DPAs in weaker cases. Yet this does not appear to be the case. The legal standard for determining whether it is appropriate for a prosecutor to proceed against the firm through a plea or a DPA is the same: Prosecutors are not supposed to seek either a conviction or a DPA unless the prosecutor believes she could establish the crime beyond a reasonable doubt.53 Indeed, rather than reserving DPAs for weak cases, the U.S. Attorney's manual directs prosecutors to employ a DPA even when

50 We focus on reliability and salience because prosecutors can disclose the same information about charges, misconduct, sanctions, corporate compliance, voluntary reforms, and mandates in pleas and DPAs (see supra Section 2, explaining that the information that can be included in the agreement is independent of the choice of settlement form).

51 Turning first to the criminal settlement itself (and associated press releases), we see that both types of resolutions trigger the same disclosure of facts. Both types of criminal resolutions can and generally do include the same information about the nature of the crime, and potential aggravating and mitigating factors, including post-crime reforms. Both tend to provide (1) a detailed discussion of the facts of the crime, including the number of offenses, their duration, locations, and involvement of senior management; (2) the charges filed; (3) the firm's admission of wrongdoing; (4) a discussion of the firm's compliance program at the time of the offense and its response to the crime (including firm-initiated reforms); (5) sanctions imposed51 including details of any mandates imposed. In both cases, the details of the resolution not only are disclosed in the agreement, but also are presented in prosecutor-issued press releases and press conferences.

52 But see supra notes 12 and 15 (discussing judicial authority over sanctions in plea agreements).

53 The legal standard for determining whether the firm engaged in misconduct under the two types of agreements is the same: respondeat superior.


the firm could easily be convicted if circumstances—such as mitigating considerations such as the firm’s compliance program, corporate self-reporting, full cooperation, and collateral consequences—warrant it. Indeed, the DOJ’s willingness to adjust the sanction independently of guilt is evidenced by recent declinations announced by the Fraud Section which insulated firms from criminal sanction, notwithstanding their violation of the FCPA, because the firm self-reported and fully-cooperated to provide prosecutors with evidence about the misconduct and those responsible for it.54

Finally, interested outsiders might assume that the use of a guilty plea, instead of a DPA, signals that the prosecutor or firm has hidden information bearing on the firm’s future risk of harm. We address this possibility below in section 4.2, focusing on the information available to the prosecutor and its role in guiding the prosecutor’s choices.

4.1.2. Salience of the Criminal Settlement

Information contained in the settlement agreement bearing on the firm’s risk of future misconduct55 could produce a greater reaction from interested outsiders when the settlement is a plea instead of a DPA if pleas are more salient than DPAs. This could occur if outsiders have easier access to the information provided through pleas than through DPAs. In addition, information in pleas would be more salient if pleas were to receive more media coverage. That is, a firm may expect a higher cost of reputational damage for a plea than a DPA if it anticipated more media attention to adverse information about the firm when released through a plea than a DPA settlement. We do not find a basis for concluding that the information conveyed through pleas is more salient, as explained below.

Prosecutors can, and do, make both corporate DPAs and pleas available to the public. Prosecutors’ offices tend to issue press releases online when entering into both forms of settlement which include a link to the actual document. This information is in turn conveyed to interested outsiders through a wide range of channels, including law firm client memos, blogs, internal company reports, and the media.

Turning to the question of media salience, we are aware of no evidence to indicate that resolution through a DPA, in and of itself, mutes press attention to the settlement. Corporate criminal settlements occur throughout any given year. Media coverage of them varies from one day to the next, and one case to the next, for many reasons—other than the form of the settlement. Indeed, the anecdotal evidence is that media coverage of criminal

54 The Fraud Section of the DOJ publicly announced declinations involving the following companies with detected bribery based, in part, on the fact that the companies voluntarily disclosed, investigated and cooperated: Nortek Inc. (June 3, 2016), Akamai Technologies Inc. (June 6, 2016), Johnson Controls (June 21, 2016), HMT LLC (Sept. 29, 2016), NCH Corp. (Sept. 29, 2016), Linde North America, Linde Gas North America LLC (June 16, 2017), and CDM Smith Inc. (June 21, 2017) https://www.justice.gov/criminal-fraud/pilot-program/declinations.

55 Throughout this section, we use the phrase the risk of future misconduct to refer to the product of the chance of misconduct by the firm and the harm to interested outsiders from that misconduct. See supra Sections 3.1, 3.2.


settlement depends primarily on the public profile of the offending firm and offense. Criminal settlements involving major corporations for offenses of concern to the public receive substantial media attention even though they were resolved through DPAs—as evidenced by the media coverage of the DPAs involving JP Morgan Chase, HSBC, General Motors, and Toyota. In contrast, less (or no) coverage accompanied the release of news about guilty pleas for economic crimes of such smaller companies as Four Seasons Property Services Inc. and Medex Ambulance Inc. This is the opposite of what would occur if the form of settlement were a reliable predictor of media coverage. For these reasons, differences in media coverage do not appear to provide a reason to expect a greater reaction by interested outsiders to a plea than a DPA, other things equal.56

Thus, the form of settlement does not, in and of itself, appear to affect the salience or reliability to interested outsiders of the information released by a criminal settlement agreement. While other features of these settlements may lead interested outsiders to place more weight on the information in one settlement agreement than another, the form of settlement does not appear to be one of those reasons.

4.2. Prosecutorial Selection: Does Conviction Reveal Hidden Information about the Crime or Internal Governance Bearing on the Risk of Future Wrongdoing?

In this section, we consider whether interested outsiders could reasonably view resolution through a guilty plea as signaling that the prosecutor has information that the firm has an enhanced risk of causing future harm (prosecutorial selection hypothesis). Pleas are likely to produce higher costs of reputational damage through this information channel only if the considerations that drive prosecutors to insist on a guilty plea are the same as the set of factors that bear on the future risk of harm to interested outsiders, as identified in Section 3. Contrary to this hypothesis, we conclude in this part that the choice of plea does not signal the risk of future harm from the firm because the considerations determining prosecutors’ choice of settlement form are not the same as those that affect the interested outsider’s expected risk of future harm from a firm that has been sanctioned for criminal misconduct. This is based on our evaluation of the federal enforcement policy and the considerations that would be most salient to a rational prosecutors’ office choice of settlement form, assuming prosecutors seek to resolve the case, with appropriate sanctions, without incurring excessive direct or indirect costs. Accordingly, prosecutors’ selection of cases for resolution through a plea instead of a DPA does not provide outsiders with a reliable signal that the firm presents a higher risk of harming them in the future.

We first identify the conditions that must be met for the prosecutor selection hypothesis to hold. We next identify the range of considerations that could influence prosecutors’ decisions to seek a guilty plea. We then identify the subset of considerations that outsiders would expect to have the greatest influence on the prosecutor’s choice of settlement form, assuming that prosecutors’ offices aim to resolve corporate cases, with

56 The similarity in media attention between cases settled as DPAs and pleas is most apparent in the cases that appear to be of particular concern to critics of DPAs: those involving large firms.


appropriate sanctions, without incurring excessive direct or indirect costs (hereinafter “focal factors”). 57 Focusing on these focal factors, we next observe that prosecutors regularly can have private information, beyond what is disclosed by the criminal settlement, about each of these factors—information that may be signaled by the prosecutors’ choice of settlement form. Nevertheless, we conclude that this signal should not affect the reactions of interested outsiders because the factors that determine the form of settlement do not reliably determine the firm’s risk of future misconduct.

Finally, we consider how prosecutors’ announced use of mandated reforms to deter future misconduct may affect interested outsiders’ reactions in ways that are inconsistent with the prosecutor selection hypothesis. This can occur in either of two plausible circumstances. First, if interested outsiders expect prosecutors to impose mandates when the firm presents a heightened risk of harm, but do not expect them to be effective, then interested outsiders should draw their inference about the firm’s future risk of harm from the prosecutors’ decision whether to impose a mandate—and not the choice of settlement form. Alternatively, interested outsiders who observe mandates that they expect to be effective at reducing future risk may conclude that the settling firm presents a low risk of harm, regardless of any negative information about the firm prior to the settlement.

4.2.1. Prosecutorial Selection: Necessary Conditions

The prosecutor selection hypothesis applies only if interested outsiders treat a prosecutor’s decision to settle through a plea instead of a DPA as evidence that the firm has an enhanced risk of harming them through a future offense. Such an inference is plausible only if the following conditions are met. First, interested outsiders must know (or be able to infer) the set of factors that consistently lead a case to settle through a guilty plea instead of a DPA. Second, prosecutors’ assessment of those focal factors must depend in part on information that is not fully disclosed in the criminal settlement document.58 In order for the prosecutor’s choice to signal this hidden information, interested outsiders must be able to infer when the prosecutor’s choice is not fully explained by her public statements about the considerations favoring a plea.59 Third, the considerations that lead

57 See supra note 48. We focus on the prosecutors’ decision under the assumption that the bargain managers can reach in return for settling rather than going to trial depends on whether the prosecutor is inclined to insist on a guilty plea. 58 If, by contrast, all information affecting the prosecutors’ choice was fully disclosed in a settlement document, outsiders would not alter their expectations about the firm’s future risk of harm based on the prosecutors’ choice of settlement form because the prosecutor’s choice would not reveal any information not fully disclosed by the settlement itself. 59 Interested outsiders cannot obtain a reliable signal of prosecutors’ hidden information when all publicly-disclosed information favors a single choice: the choice the prosecutor made. This circumstance could arise if (1) the prosecutor had additional hidden information that reveals the firm is even riskier than disclosed, (2) the prosecutor had no hidden information, (3) the prosecutor had hidden information favoring the other choice unrelated to the risk of future harm, or (4) the prosecutor had hidden information favoring the other choice that was unrelated to the risk of future harm. Absent a divergence between the information revealed and the choice made, it is difficult for interested outsiders to infer the type of hidden information observed by prosecutors.


prosecutors to seek a guilty plea must reliably indicate that the firm has a relatively higher risk of causing future harm to interested outsiders (see Section 3 supra). The situation where a plea may signal hidden information about such risk is illustrated in Figure 3.

Insert Figure 3 here When these considerations are met, interested outsiders can infer from the prosecutors’ insistence on settling through a guilty plea that the available information, as of the time of the criminal settlement, led the prosecutor to anticipate an enhanced risk of future misconduct by the firm. This could lead them to be less willing to deal with a firm that pled guilty than one that entered into a DPA with otherwise identical terms. 4.2.2. Candidate Factors Potentially Affecting Prosecutors’ Choices

Prosecutors' decisions to convict are potentially affected by two types of considerations. The first are those that are set forth in the United States Attorneys’ Manual Principles of Federal Prosecution of Business Organizations (the "Principles"). 60 The second are considerations relating to the effect of a plea on the ability of the prosecutors’ office to achieve an assumed central aim: which is to resolve corporate criminal cases imposing appropriate sanctions and mandates without imposing excessive costs, as explained below (hereinafter efficiency objective).61

60 U.S. Attorney's Manual, 9-28.000. https://www.justice.gov/usam/usam-9-28000-principles-federal-prosecution-business-organizations. We focus on the Principles because they govern the majority of corporate criminal settlements involving publicly held firms. For a discussion of the Principles see, e.g., Alexander and Cohen (2015) and Arlen (2015).

Most corporate criminal settlements are governed by the Principles of Federal Prosecution of Business Organizations contained in the U.S. Attorney's Manual. Of course, not all cases are governed by the Principles. Certain divisions in the Department of Justice, such as Antitrust and Environmental, have their own guidelines governing the decision to enter into a plea or a DPA. The environmental division tends to favor conviction for almost all corporations (see findings of Alexander and Cohen 2015). The Antitrust Division uses DPAs and NPA, but rarely. It reserves these forms of settlement for the first member of cartel to self-report https://www.justice.gov/atr/page/file/926521. (See Alexander and Cohen, 2015, p. 571, 95% of criminal antitrust cases in a sample of federal criminal settlements with public companies as signatories were resolved through guilty pleas).

We do not further consider variation across enforcement areas – e.g., divisions, offices and offense types – in this chapter. We note, however, that the announcement of policies that cause outsiders to anticipate that one form of settlement (e.g., a plea) will be used in almost all cases reduces the informational impact of a decision to use that form, and that the same announcement will increase the informational impact of the use of the other settlement form (e.g., a DPA).

61 See supra note 48. Prosecutors may face incentives to structure current settlements to send signals to firms that prosecutors hope can benefit them in future cases, especially in offices that regularly enter into corporate settlements. In particular, they may consider the incentives they provide to corporations to self-report and fully cooperate by a systematic practice of using different settlement forms for firms that self-report or cooperate and those that do not. See, e.g., The Fraud Section's Foreign Corrupt Practices Act Enforcement Plan and Guidance (April 2016) (hereinafter FCPA Pilot Program) https://www.justice.gov/criminal-fraud/file/838416/download.


Most corporate criminal settlements are governed by the Principles of Federal Prosecution of Business Organizations contained in the U.S. Attorneys' Manual (USAM). The Principles provide a public statement of factors that prosecutors should consider when deciding whether to convict or enter into a DPA, and thus reveal to interested outsiders many of the considerations that influence prosecutors' choices. Prosecutors often will have hidden information relating to some of these considerations.

The Principles sets forth 10 factors that prosecutors generally should consider when deciding whether to convict (9-28.300). These ten factors are (1) The nature and seriousness of the offense including the harm to the public; (2) the pervasiveness of the wrongdoing within the firm and management complicity in perpetrating or condoning the crime; (3) the corporation's history of similar misconduct; (4) the quality of the compliance program at the time of the misconduct; (5) the firm’s timely and voluntary disclosure of wrongdoing; (6) the firm's remedial actions including compliance program reform, actions against individuals, and restitution; (7) corporate cooperation; (8) whether agencies' regulations provide that conviction for the offense triggers mandatory or permissive debarment or delicensing, and thereby impose disproportionate harm on shareholders, employees, customers, pensioners or others who were not personally culpable; (9) the adequacy of other remedies, such as civil or regulatory enforcement actions; and (10) the adequacy of individual prosecutions.

Prosecutors tend to make public statements in the criminal settlement agreements and accompanying disclosures about their conclusions with respect to the USAM factors.62 Yet those statements often do not reveal all the material information observed by prosecutors about the USAM factors and other factors influencing their choice. For example, prosecutors may mention collateral sanctions (such as exclusion) but often do not disclose the full range and magnitude of those collateral sanctions both in the U.S. and abroad that could be triggered by conviction immediately or in the future. In addition, prosecutors tend to make summary statements that the firm did or did not fully cooperate, without going into detail about the genuineness and fullness of the cooperation.63 Hidden

62 Prosecutors reveal their conclusions regarding the USAM factors both in the course of discussing the choice of resolution and also when presenting criminal fine calculations under the U.S. Sentencing Guidelines Governing Organizations.

63 Criminal settlement agreements generally state if a conviction would trigger exclusion by a federal agency. Yet the magnitude of the impact on the firm of exclusion generally is not disclosed. Agreements also do not tend to discuss the firm’s statements regarding the potential threat to it of debarment or delicensing by foreign government authorities now or in the future.

Similarly, statements that misconduct was widespread tend to exclude discussion of detected but uncharged misconduct. They also regularly include conclusory statements about whether the firm had "an effective compliance program,” without revealing the underlying factual bases for, and the degree of the prosecutor’s conviction in, that conclusion.

In addition, prosecutors' decisions often are influenced by two other types of hidden information. First, in situations where the ten USAM factors do not all favor the same choice, the decision to convict will depend on an additional consideration: the identity of the subset of factor(s) that this prosecutor considers


information on USAM factors favoring a guilty plea thus may be signaled by a prosecutor’s choice to seek a guilty plea in a case where some USAM factors favor a plea whereas others do not.64

Although prosecutors’ decisions can be affected by hidden information bearing on the USAM factors, whether an interested outsider would regard the choice as a signal of hidden information about the risk of future harm depends on whether he regards the considerations that influence the choice of settlement form to be reliable indicators of that risk. To assess this, we begin with the USAM. Some of the USAM factors—specifically USAM factors (1) – (6) – do bear on the risk of future misconduct. But, as will be explained in detail below (see infra Section 4.2.4.), other factors that influence prosecutor choice have nothing to do with the prospect of future misconduct. Accordingly, in order to assess the prosecutorial selection hypothesis, we first identify the subset of the USAM factors that influence the decision whether to encourage a guilty plea instead of a DPA from a firm that is inclined to settle, and then determine whether any of those factors have bearing on the risk of future harm.

4.2.3. Identifying Prosecutors' Focal Criteria

In this part, we identify the considerations that are likely to be focal for a prosecutor

most important in deciding which form of criminal settlement to seek. The prosecutor's personal weighting of the various factors matters because the USAM gives prosecutors discretion to determine which USAM factors to accord the most weight when deciding whether to convict. As a result, a prosecutor can employ a DPA even when all but one of the USAM factors favor conviction if the factor is one the prosecutor considers to be outcome-determinative (e.g., self-reporting or collateral consequences).

64 In some situations, the settlement document may fully reveal that all ten USAM factors favor a particular choice, for example to require a conviction. In this instance, the decision to convict does not reveal anything new about the prosecutor's private weighing of USAM factors. When all publicly-available factors favor a particular choice, the prosecutor who selected that choice could have had (i) no additional hidden information, (ii) additional hidden information favoring the choice (that could be related or unrelated to the risk of harm), (iii) additional hidden information weighing against the choice that was unrelated to the risk of future harm, or (iv) additional hidden information weighing against the choice that was related to the risk of harm but which did not alter the outcome because the prosecutor placed little weight on that factor. As a result, when all the USAM factors point in the same direction, differences in the conditions leading to the selection of a plea versus a DPA should not lead to differences in the cost of reputational damage between the two forms of settlement.

Thus, the actual decision to use a plea should not affect the reputational damage cost imposed on a firm for a crime that would not trigger collateral penalties, involving many charges for misconduct by senior managers occurring over a long period of time, that was detected but not self-reported, and where the firm obstructed the prosecutors' investigation instead of cooperating. Interested outsiders might be less willing to deal with such a firm, but their decision would be based on the negative facts disclosed in the criminal settlement and not on the prosecutors' ultimate decision to convict in this instance. Nor can interested outsiders infer anything relevant to reputational damage costs from the fact that the prosecutor selected a settlement form consistent with the USAM factors and not contrary to them. When all USAM factors point in the same direction, a prosecutor would go the other way only if he chose to disclose information that is contrary to his choice and keep hidden the information that supports his choice. This is unlikely unless the prosecutors' decision was predicated on factors (such as strategic factors) not listed in the USAM. These are not likely to indicate the firm’s risk of future misconduct.


in choosing between a plea and a DPA. Prosecutors have discretion to decide how to weigh the various USAM factors. This includes authority to focus on a subset of factors. They also are explicitly authorized by the USAM to take into account considerations beyond the ten expressly-listed factors.65

Prosecutor, operating through offices of the USAOs and Main Justice, achieve objectives of criminal enforcement when entering into a corporate criminal settlement that include specific deterrence, general deterrence, and punishment. Prosecutors achieve these objectives by setting the terms of the settlement agreement—the charges, statement of facts, monetary sanctions and mandates. They can employ these provisions in either a plea or a DPA and thus can achieve its over-arching objectives through either form of settlement (setting aside for a moment the issue of reputational damage costs) (see supra Section 2). Of course, prosecutors can only use criminal settlements efficiently to deter and punish to the extent that they can efficiently detect misconduct and obtain the needed evidence. In addition, they must be able to settle the case efficiently, at the lowest cost required to achieve the prosecutors’ objective (in terms of litigation costs or additional negotiations with outside agencies).

In light of these considerations, prosecutors’ offices, given discretion, can be expected to focus on the considerations that enable them (and in turn the DOJ) to efficiently resolve the corporate criminal case.66 That is, holding constant the charges, the monetary sanctions, statement of facts, and mandates contained in the criminal settlement agreement, a prosecutor considering the choice between a plea and a DPA can be expected to consider the direct and indirect cost to the prosecutors’ office, the DOJ, and the public of selecting one settlement form over another. As a result, a prosecutor can be expected to consider whether insistence on a guilty plea instead of a DPA would lead the firm to reject settlement or, alternatively, require the prosecutor to incur the added cost and delay of negotiating side deals with multiple agencies in order to enable the firm to plead guilty without fear of financial ruin. Prosecutors also may consider the degree to which offering (or signaling a willingness to offer) a DPA could facilitate this particular settlement—and potentially future corporate criminal cases—by providing an incentive for the firm to self-report detected wrongdoing and/or to fully cooperate to enable the government to readily obtain evidence about the misconduct and those responsible that prosecutors often could not easily

65 U.S. Attorney’s Manual, Principles of Federal Prosecution of Business Organizations, § 9-28.300 (comment b); see U.S, Attorney’s Manual, Principles of Federal Prosecution of Business Organizations, § 9-28.900 ("Prosecutors have substantial latitude in determining when, whom, how, and even whether to prosecute for violations of federal criminal law. In exercising that discretion, prosecutors should consider the following statements of principles that summarize the considerations they should weigh and the practices they should follow in discharging their prosecutorial responsibilities."). 66 The prosecutor might perceive the benefit and cost as accruing to prosecutors’ office and/or to the Department of Justice. The conclusions of this part apply independently the prosecutor’s views on how the benefits and costs of the individual case resolution are distributed across the offices of DOJ or between those offices, on the one hand, and outside parties, on the other.


obtain otherwise.67 Finally, prosecutors may consider whether a plea would inefficiently impose costs on the innocent third parties, such as customers.

Thus, prosecutors seeking to achieve an efficient resolution can be expected to focus on three considerations: the potential threat to the firm and its customers of exclusion or delicensing, whether the firm that detected misconduct reported it or not, and the degree to which the firm conducted a full investigation and cooperated with authorities, or, alternatively resisted the government’s efforts to obtain information.

Interested outsiders would reasonably expect such a prosecutor to presumptively avoid a guilty plea for charges that would leave the firm vulnerable to mandatory or permissive exclusion or delicensing for several reasons. First, prosecutors interested in resolving the matter quickly should favor a DPA because corporations have strong incentives to resist settlement through a plea if it would trigger debarment or exclusion. Prosecutors thus may prefer DPAs under these circumstances as DPAs enable them to resolve the case more efficiently, without reducing either the sanctions prosecutors can impose or federal agencies’ ability to exclude a firm through their own processes if they so choose (see infra Section 5). Second, prosecutors acting as loyal agents of the DOJ should favor DPAs in these cases because the DOJ as a matter of policy has indicated a preference for settlement without conviction when conviction could trigger exclusion or delicensing that would harm innocent third parties, such as customers.68 Finally, prosecutors may prefer to avoid pleas that would trigger exclusion or delicensing that would harm innocent customers. As a result of these considerations, the outsider would not expect a prosecutor to insist on a plea in a case likely to trigger exclusion or delicensing unless there is known to be an offsetting policy goal (such as to sanction a firm that impeded an investigation).69

67 The use of enforcement policy to incentivize self-reporting and cooperation promotes efficient settlement in two ways. First, prosecutors who individually expect to be repeat-players in these types of cases would have an incentive to structure enforcement to signal future firms that they will be better off if they self-report and fully cooperate. Second, prosecutors acting as loyal agents for the DOJ would have an incentive to take actions likely to lead future firms to self-report or cooperate with prosecutors in other offices immediately and in the future (see generally Arlen and Kraakman 1997). Consistent with this, the Fraud Section's Pilot Program places particular emphasis on whether a firm self-reported. This can affect the type of resolution, magnitude of the fine and whether a monitor is imposed. See Fraud Section Pilot Program, supra note 61.

68 In discussing collateral consequences (USAM 9-28.1100), the USAM lists a range of collateral consequences (including harm to employees, investors, pensioners and customers), but singles out as a collateral consequence of settlement—such as debarment and exclusion—harm to innocent third parties, such as customers, as a consideration favoring “a non-prosecution or deferred prosecution agreement with conditions designed, among other things, to promote compliance with applicable law and to prevent recidivism…[because o]btaining a conviction may produce a result that seriously harms innocent third parties who played no role in the criminal conduct.” The DOJ notes that a DPA in this situation can “help restore the integrity of a company's operations, … preserve the financial viability of a corporation that has engaged in criminal conduct, … [preserve] the government's ability to prosecute a recalcitrant corporation that materially breaches the agreement, [and potentially provide] prompt restitution for victims.”

69 Even in this situation, the benefit of using the plea to achieve the offsetting policy goal would need to exceed the added costs to the prosecutor (of the adjustments needed to employ a plea without triggering federal exclusion or delicensing) that include the costs of time and attention that is required to negotiate with


In most other cases, prosecutors may be able to achieve their enforcement objectives by incorporating the appropriate provisions on monetary sanctions and mandates into a DPA. Overall, prosecutors presented with a firm that would be threatened by collateral consequences appear to have strong incentives to use a DPA.70

Prosecutors also can be expected to employ DPAs with firms that self-reported, fully cooperated and remediated, as well as with firms that failed to self-detect but later provided genuine full cooperation and remediated. The DOJ highlighted the separate and distinctive importance of self-reporting and cooperation when it revised the Principles in 2015 specifically to treat self-reporting and full cooperation as independent factors. It further highlighted its focus on self-reporting and full cooperation in the FCPA Pilot Program adopted by the Fraud Section in April, 2016.71 The Pilot Program effectively creates a presumption against convicting firms that self-report or fully cooperate. Such a presumption incentivizes firms to self-report and cooperate. Self-reporting and cooperation saves the DOJ resources that it could otherwise devote to detection and investigation. Efforts to encourage these activities would be undermined were prosecutors to regularly require firms that self-report and cooperate to plead guilty (Arlen and Kraakman 1997; Arlen 2012a). In turn, the DOJ has encouraged the use of guilty pleas against firms that resist full cooperation, especially if they impede the government’s investigation. To obtain pleas in such cases, prosecutors have been willing to negotiate with multiple agencies to obtain waivers of exclusion and debarment, apparently concluding that the message to future corporate defendants warrants the added cost of these negotiations.72

the relevant federal, state and foreigner government authorities to obtain a waiver of exclusion or delicensing, if possible, or alter the charges to avoid the collateral sanctions (as discussed in Section 5).

70 Indeed, the General Accountability Office examined DPAs and identified collateral penalties as the central consideration in determining whether a firm gets a DPA (see GAO Report 2009, identifying collateral consequences as a central consideration in the decision to impose DPAs). Alexander and Cohen provide evidence that is consistent with our conclusion. To the extent that plea agreements with parent corporations expose more business units of the firm to U.S. collateral sanctions than do plea agreements with their subsidiaries (which may be foreign), we would prosecutors to be relatively more inclined to use DPAs to resolve cases with parent corporations. Consistent with this, Alexander and Cohen find that prosecutors settling with a corporate group (a public parent and a subsidiary) usually a DPA (61%) to settle with of the parent and a guilty plea when settling with the subsidiary (Alexander and Cohen 2015, p. 580).

71 FCPA Pilot Program, supra note 61.

72 For example, in announcing the first two guilty pleas against financial institutions, DOJ officials explicitly cited the firm’s failure to cooperate as a reason for the plea. In the press release announcing the conviction of BNP Paribas quoted the Deputy Attorney General:

“BNP ignored US sanctions laws and concealed its tracks. And when contacted by law enforcement it chose not to fully cooperate…This failure to cooperate had a real effect -- it significantly impacted the government’s ability to bring charges against responsible individuals, sanctioned entities and satellite banks. This failure together with BNP’s prolonged misconduct mandated the criminal plea and the nearly $9 billion penalty that we are announcing today.”

https://www.justice.gov/opa/pr/bnp-paribas-agrees-plead-guilty-and-pay-89-billion-illegally-processing-financial.

Credit Suisse was also required to plead guilty for conspiracy and aid-and-assisting U.S. taxpayers’


Thus, an interested outsider can be expected to conclude that the three most important factors in determining whether a prosecutor prefers a DPA are whether a plea would trigger exclusion or delicensing, whether the firm self-reported, and whether the firm fully cooperated, on the one hand, or resisted the government’s efforts to investigate the crime, on the other. In cases where the use of a DPA or a plea appears to be consistent with these considerations, we expect interested outsiders to conclude that prosecutors focused on these considerations, including any hidden information about the fullness of the self-reporting or cooperation and the extent of the threat of exclusion or delicensing.

Of course, there are cases where the choice of settlement form does not appear to be explained by the three considerations discussed above. Yet even here a reasonable interested outsider would be unlikely to assume that the choice of settlement form was based on the firm’s risk of future misconduct and related harms. First, the decision may not provide a signal because it could reflect either the prosecutors’ idiosyncratic views on the importance of guilty pleas, on the one hand,73 or her willingness to offer a DPA in exchange for some other concession, on the other. It could also depend on undisclosed considerations that do not bear on the firm’s future risk of harm: for example, a prosecutor might prefer a plea for a crime that caused death or seriously bodily injury if she could convict the firm without harming innocent customers. Finally, the choice might depend on considerations that are fully disclosed in the agreement. Given how many considerations could plausibly lead a prosecutor to make a decision contrary to expectations, the likelihood of an interested outsider deriving a reliable signal from the choice appears to be low.

4.2.4. Do the Focal Considerations Signal Hidden Information about the Firm’s Future Risk of Harm

Having assessed the three considerations likely to determine prosecutors’ choice of settlement form, we next turn to the question of whether an interested outsider would likely interpret a prosecutor’s selection of a plea based on these criteria as a reliable signal of heightened risk of future harm. We first determine that prosecutors’ decisions regarding these three considerations can be based on hidden information. We then evaluate whether the three focal considerations (collateral consequences, self-reporting, and full cooperation) are plausible indicators of the risk of future misconduct. A conclusion that they are not would lead us to the result that any hidden information conveyed about these three considerations by prosecutors’ choices would not provide a reason for interested outsiders to be less willing to deal with the firm in the future.

Prosecutors’ choices can convey undisclosed information even though prosecutors often include explicit statements about the USAM factors and reasons they selected a

tax evasion. The misconduct included failing to provide accurate information to federal authorities. In the plea, the firm got no credit for self-reporting or cooperating. https://www.justice.gov/ iso/opa/resources/6862014519191516948022.pdf.

73 See GAO Report (2009) finding that many U.S Attorneys’ Offices never entered into DPAs whereas a subset used them regularly.


particular settlement form in the agreement or press release. These public statements do not reveal all the information that may have affected the choice because the statements are often summary conclusions and incomplete. For example, prosecutors tend to disclose that a firm “self-reported” or “cooperated” without disclosing all the information known to the prosecutor bearing on the timing, completeness, and managerial support for these undertakings—considerations that may well affect the choice of settlement form. Nor do statements about collateral consequences disclose all information relied on by the prosecutors on the expected cost to the firm of any delicensing or exclusion of a firm that could be triggered by a plea agreement to the charges the prosecutor considers appropriate.74

Yet any information about the three focal considerations signaled by prosecutors’ choice of settlement form should not affect a firm’s cost of reputational damage because there is no reason to believe that these three factors, individually or jointly, are reliable indicators of the risk of future harm from the firm.

Consider first the potential threat of corporate delicensing or exclusion. Although administrative agencies tend to have discretion not to exclude or delicense a convicted firm even when a conviction could trigger these collateral sanctions, firms would reasonably resist pleas that could trigger exclusion or debarment because the decision whether to accept a plea usually is typically made before the agency has indicated whether it would exclude or delicense the firm if convicted. Accordingly, firms, and thus prosecutors, can be expected to predicate their bargaining position on whether, under the law, conviction on a particular set of charges could trigger exclusion or delicensing even if the agency probably would not exclude a convicted firm with a low risk of future harm (see infra Section 5). Thus, in considering collateral consequences, prosecutors will focus on considerations relating to the consequences of exclusion even when the probability of exclusion is low. Examples include: whether and, if so, the extent to which, the firm sells goods or services under the authority of a federal, state, or local agency with exclusion authority; the number of potential agencies implicated; whether conviction would trigger mandatory or permissive exclusion, the agencies’ policies and practices governing exemptions from exclusion, including the agencies’ willingness to waive exclusion ex ante, before the criminal settlement is finalized.

Prosecutors also may predicate their choices on corporate self-reporting. This consideration also does not reliably signal the firm’s risk of future harm because, under existing enforcement policy, a firm that is committed to legal compliance nevertheless may decide not to self-report because corporations’ expected criminal liability often is higher if they self-report than if they do not (Arlen and Kraakman 1997; Arlen 2012b).75 Because

74 For example, prosecutors tend not to disclose in the settlement agreement either their personal views on the appropriateness of using DPAs or their assessment of senior managements’ culpability or the chance of a future offense.

75 An optimal enforcement policy would ensure that firms have a strong incentive to self-report and


self-reporting enables the government to sanction the firm for misconduct that might have escaped detection, firms have a good reason not to self-report unless they offered a sufficient benefit—such as a superior form of settlement or an adequate reduction in the sanctions imposed (Arlen and Kraakman 1997; see Arlen 1994).76 In weighing the benefit, the firm will consider the settlement it would expected should it self-report relative to the settlement it expects to receive should it fully cooperate after failing to self-report. A firm might conclude it would not obtain a sufficient benefit from self-reporting if it does not otherwise expect the crime to be detected, and it expects that, upon detection, the prosecutor would enter into a DPA in return for full cooperation (even if it does not self-report). In addition, large firms that self-report obtain a relatively small percentage reduction in their fine under the Organizational Sentencing Guidelines, relative to what they can get by cooperating alone (Arlen 2012b).77 Finally, firms operating overseas may be deterred from self-reporting to the U.S. authorities if self-reporting may trigger enforcement actions overseas in a country that does not provide any leniency for self-reporting. Consequently, a firm may fail to self-report for the simple reason that doing so would increase its excepted costs, even though it is committed to deterring misconduct and thus has a low probability of future misconduct. By contrast, a firm that detects wide-spread misconduct might choose to self-report—notwithstanding its apparent high risk of future crime—if it fears a whistleblower will report any one of its crime, especially if it can report to an office that strongly rewards self-reporting, such as the Fraud Section. Thus, signals sent by prosecutorial decisions predicated on corporate self-reporting do not systematically bear on the interested outsider’s risk of future harm from the firm.

Finally, and similarly, prosecutors’ hidden information about corporate cooperation—and non-cooperation—also does not reliably signal the firm’s future risk of harm. It is likely that some firms fail to cooperate because management is not committed to legal compliance. Yet more generally it appears that firms decide whether to cooperate or not for reasons that are independent of their risk of causing future harm to interested outsiders. Anecdotal evidence suggests that U.S. firms with U.S. counsel generally cooperate—independent of future risk—in order to obtain a DPA and other benefits. The anecdotal evidence is that the firms that fail to cooperate fully and in a timely way often are foreign firms which are either unaccustomed to cooperating with government

fully cooperate. In this case, a firm that self-reports is likely to do so in the future, creating expectations of a heightened risk of detection that deters employees from future crime (Arlen 1994; Arlen and Kraakman 1997). Existing enforcement policy does not reliably ensure that firms are better off if they self-report and cooperate (Arlen 2017).

76 Moreover, the firm will only self-report and cooperate if the benefit of the additional reduction in expected sanctions for self-reporting, relative to the expected sanctions for full cooperation exceed cost to it of reporting a crime that might have gone undetected (Arlen 2012b).

77 Indeed, the disincentive to self-report is particularly great for large firms operating in many countries. Large firms can rely on no more than a 50% reduction in their fine relative to the fine if they cooperated but failed to self-report under both the Organizational Sentencing Guidelines (Arlen 2012b, at 348) and the FCPA Pilot Program, supra note 61.


investigators, or are constrained by laws in their country of origin against providing the access to employees, emails, and internal data required by U.S. prosecutors (see Garrett 2011, finding that foreign firms are more likely to be convicted).78

Accordingly, we conclude that the criteria relied on by prosecutors when determining whether to insist on a guilty plea do not indicate a heightened risk of future harm. That is, interested outsiders who observe that a case was settled through a plea can be expected to infer hidden information about the risk of debarment or exclusion, or the firm’s commitment to self-reporting and cooperation, but will not derive a signal about hidden information that reliably indicates that the firm presents a higher risk of future harm to interested outsiders, as illustrated in Figure 3.79

Insert Figure 4

4.2.5. Dynamic Considerations: Impact of Reforms

Finally, we consider whether the ability of the prosecutor to encourage reforms or impose mandates as part of the settlement process might affect the interested outsider’s beliefs about whether the prosecutor’s decision to require a plea, instead of a DPA, provides a reliable a signal of the future risk of harm from the firm.

Both DPAs and guilty pleas are accompanied by the release of information about voluntary and mandated reforms that are ostensibly undertaken to reduce the risk of future misconduct (see supra Sections 2.3 and 3.3.2.2). Criminal settlements regularly disclose voluntary reforms such as changes to the firm’s compliance program and changes in management. Prosecutors also regularly (and in the case of DPAs, usually) use criminal settlements to mandate reforms beyond those undertaken voluntarily (see Alexander 1999, Arlen and Kahan 2017, Alexander and Cohen 2015). These mandates include detailed and prescriptive reforms of the firm's compliance program, additional internal oversight requirements for certain contracts, and limitations on certain types of contracts or lines of business that present a heightened risk of misconduct. In addition, the settlement agreement may compel the firm to incur the costs of appointing and maintaining an external monitor (Alexander and Cohen 2015, Arlen and Kahan 2017, see Khanna and Dickerson 2007).80

78 For example, the management of the firm might not provide U.S. prosecutors with the full results of their own investigation if they are unaccustomed to the U.S. approach to corporate investigations, or are governed by foreign laws (or subject to instructions from foreign enforcers) that limit their ability to fully cooperate.

79 Of course, not all cases are driven by these factors. Yet even in these cases the prosecutorial selection hypothesis generally will not hold. So many considerations can affect the choice of settlement form—including prosecutors’ personal preference—that interested outsiders are unlikely to be able to reliably infer which factors determined a choice not explained by the three focal factors. Moreover, even if they can, many considerations likely to impact prosecutors’ choice, such as the magnitude of the publicly-disclosed harm or the difficulty of obtaining evidence—either are fully disclosed in the settlement document or do not indicate a higher risk of future harm. See also supra note 64 (explaining why the prosecutors’ choice does not signal private information when all candidate factors favor the choice the prosecutor made).

80 While modern criminal settlement agreements now regularly include an explicit discussion of voluntary and mandated reforms, the practice of announcing governance reforms at the news of corporate


These mandates undermine the prosecutorial selection hypothesis in either of two situations, depending on interested outsiders’ beliefs about why they are imposed and their likely effect. Consider first interested outsiders who believe that prosecutors impose certain types of mandates, such as monitors, when they have information indicating that the firm presents a higher risk of future misconduct. In this situation, a prosecutor’s choice of mandate should provide a stronger signal about the prosecutor’s undisclosed information about the firm’s future risk of harm than her choice of whether to settle through a DPA or a plea. Interested outsiders can be expected to predicate their responses to the criminal settlement on the decision whether to impose significant mandate, rather than on the choice of settlement form, especially since the latter tends to be determined by factors uncorrelated with the risk of harm, as we have seen.

Alternatively, interested outsiders may believe that certain types of mandates—for example external monitors—are effective at deterring misconduct. Criminal settlement agreements that contain credible statements about apparently effective reforms may lead interested outsiders to conclude that the conditions that led to the past offense will not be present going forward. In this case, outsiders may not expect an enhanced risk of harm from a firm that entered into a guilty plea—even if the outsiders received a strong signal that the firm had an enhanced risk of future harm at the time of the crime—if the plea agreement imposed a set of mandates that outsiders expect to be effective at deterring misconduct. Indeed, if voluntary and mandated reforms produce firms with effective internal governance, interested outsiders might well expect less risk of harm from such firms than from the average firm.

For these reasons, under plausible assumptions about how interested outsiders respond to reforms, the prosecutor’s preference for encouraging reforms or imposing reform mandates would not cause her use of a plea to be a reliable signal of the risk of future harm to the interested outsider. This is regardless whether the reforms and mandates are themselves effective in preventing future misconduct.

4.4 Management Selection: Does Conviction Reveal Agency Problems in the Firm?

The management of the firm negotiates the settlement with the prosecutor in coordination with the firm’s other agents, such as lawyers and the board of directors. Thus, interested outsiders may derive a signal about management’s hidden information from the chosen form of settlement. We now consider whether use of a guilty plea instead of a DPA could reasonably be interpreted by interested outsiders as a signal that management has information that the firm has an enhanced risk of harm from a future offense (Managerial Selection Hypothesis).81

crime is not new. In her study of reputational damage costs following criminal and civil settlements for corporate fraud prior to 1999, Alexander found that 40 percent of the companies announced new training, audit, and monitoring programs, as well as other reputation-rebuilder actions. Alexander (1999, at 514 table 4). More recent studies have documented the presence of similar undertakings as mandates in DPAs (Arlen and Kahan 2017).

81 Managers can influence the outcome in two ways: directly through their stance during the


First, managers may have hidden information about either the misconduct or the firm bearing on the expected payoff to the firm of entering into a guilty plea versus going to trial. For example, even when there is no risk of exclusion by federal agencies, management may prefer a DPA based on insider knowledge of the cost to the firm of potential collateral sanctions imposed by state or foreign government agencies.82 They also may have hidden information about the firm’s ability to withstand either a protracted settlement negotiation or the costs and risk of going to trial. Each of these types of information can be expected to influence management’s willingness to accept or resist a guilty plea. Yet these factors do not appear to be related to the risk of harm from a future offense, and thus decisions based on these considerations should not affect the interested outsiders’ expected risk of future harm from dealing with the firm.

Second, interested outsiders might view managements’ decision to accept a guilty plea as providing a negative signal about management’s type. This could occur if interested outsiders expect management to cause the firm to enter into a plea instead of a DPA in return for private gain in the form of insulation from individual prosecution.83 Settlements that sacrifice shareholder interests for managers’ private gain could signal the presence of weak internal governance and agency problems within the firm that an outsider may associate with a heightened the risk of future misconduct by the firm.84 Separately, such settlements also would signal weak internal governance within the DOJ as such settlements would allow the culprits to escape punishment in order to enable prosecutors to obtain a corporate guilty plea. If these settlements occurred regularly, then pleas could lead firms to bear higher costs from reputational damage by signaling that managers were complicit but avoided sanction by having the firm plead guilty, and now remain at the firm, potentially willing and able to violate the law with sanctions imposed on organizations but not on individuals.85

negotiation and indirectly through decisions they make regarding the compliance, the investigation, self-reporting, and remediation. We focus on the former because managers’ pre-negotiation actions are only relevant if those actions tend to affect the prosecutors’ decisions to pursue a conviction or a DPA in ways that indicate a heightened risk of future wrongdoing. Were this the case, we would expect the Prosecutor Selection Hypothesis to apply.

82 They also may have information about the likelihood that the firm would expand into new jurisdictions in the future in which a past conviction could preclude the firm from engaging in profitable lines of business.

83 In 2015, the Department of Justice formally adopted a policy designed to discourage this practice. See Yates memo, supra note 7. It is difficult to determine the extent to which these types of settlements have occurred. First, individual convictions often follow corporate criminal settlements, instead of being resolved contemporaneously. Second, in cases where the wrongdoer lives overseas, the individual may be prosecuted by a foreign justification. Nevertheless, if one examines DPAs entered into before the Yates memo one does find some agreements with provisions stating that no individual convictions will follow.

84 See, e.g., Macey (1991), Arlen and Carney (1992), Alexander and Cohen (1992, 1996). 85 As with prosecutorial selection, the Managerial Selection Hypothesis holds only if three conditions must be met. First, managers' decision whether to accept a plea must depend on hidden information. Second, interested outsiders can predict the factors that would lead management to accept a conviction instead of a DPA. Third, the factors likely to lead to a guilty plea also indicate a heightened risk of future wrongdoing.


Although it is possible that managers occasionally do protect themselves at the firm’s expense, we conclude, based on examining cases of corporate misconduct and the standard bargaining process that produces a corporate criminal settlement, that interested outsiders, aware of this process, are unlikely to view a guilty plea as a reliable signal that the firm is managed by individuals complicit in, able to avoid, and still willing to commit, misconduct for two reasons.

First, many criminal settlements are for offenses that do not implicate senior management. Bribery of foreign officials, for example, rarely involves managers in the C-suite. Members of senior management who are not implicated in the offense have no opportunity to accept a guilty plea for private gain. Thus, in these instances, a plea does not produce a plausible signal of a principal-agent problem in that firm.86 Second, when management is implicated in the crime, they generally should be unable to obtain a settlement that protects themselves at the expense of the firm. In this situation, boards of directors generally delegate oversight of the investigation and the settlement negotiations to a committee of independent directors. This committee has little reason to accept a guilty plea to protect senior management, particularly in light of the potential threat of personal liability should they so act in bad faith.87 In addition, under DOJ policy, prosecutors generally should neither offer nor accept a guilty plea in return for insulating individuals. Indeed, a memo issued by Deputy Attorney General Eric Holder in 1999 specifically mentioned the importance of individual prosecutions. A subsequent memo, issued by then Deputy Attorney General Sally Yates in 2015 clearly stated that prosecutors should seek individual prosecutions whenever possible, and required them to justify any corporate conviction that is not accompanied by charges against the individuals responsible for the crime. Prosecutors thus should be resistant to any effort by senior management to sacrifice the interests of the firm to protect themselves and subject the firm to the resulting costs. As

86 Of course, management may seek other concessions that confer a personal benefit in return for a plea. For example, management might be willing to accept a plea to avoid intrusive mandates, such as a monitor. According to Arlen and Kahan (2017), a prosecutor serving the public interest should not agree to this deal. They argue that mandates designed to provide external oversight over compliance (“external meta-policing”) mandates, such as monitors, are needed in precisely this situation: where management obtains a personal benefit from a weak corporate compliance program. From this perspective, this channel would operate to cause pleas to trigger enhanced costs from reputational damage only if prosecutors do not act in the public interest.

87 Corporations not only often delegate oversight of criminal investigations and settlements to a committee of independent directors, but also regularly authorize the independent committee to hire its own counsel. The committee’s express objective is to act in the best interests of the firm. The committee should resist a guilty plea unless total cost to the firm of the settlement offered involving a plea is less than the total cost to the firm of the settlement offer through a DPA. Boards that allow a corporate conviction in order to protect individual managers could be subject to personal liability imposed through a shareholder derivative suit. See Stone v. Ritter, Dela (2006) (directors can be liable for if they intentionally fail to act in the best interests of the firm). Finally, in situations where a plea could trigger substantial collateral sanctions, the senior managers and directors who are not implicated in the crime have a private incentive to resist any effort to have the firm accept a plea in order to insulate the wrongdoers because, under the assumption that the plea would limit the business prospects of the firm, it also would limit the business prospects of the firm’s management as such.


a result, when a firm accepts a guilty plea, it is unlikely to lead interested outsiders to conclude that the firm has a high risk of future harm because its senior management was complicit in the crime and had sufficient influence to use the corporate settlement to escape punishment.

Finally, from a policy perspective, even if managers were able to protect themselves by causing the firm to plead guilty, this would not justify a policy favoring guilty pleas as a means of increasing adding a cost of reputational damage to the total sanction. Managerial Selection would enhance the cost of reputational damage only if guilty pleas systematically involve settlements that insulate culpable senior managers from prosecution. This channel for reputational damage would hardly be an argument favoring pleas because deterrence would be undermined—and not enhanced—by corporate convictions that insulate the individuals responsible for the crime from prosecution (Arlen 1994, Arlen and Kraakman 1997). Thus, to the extent that pleas impose enhanced costs of reputational damage through this channel, society would be better off by weakening prosecutors' motivation to obtain a plea, instead of enhancing them.

4.5. Summary: What can Outsiders learn from Conviction about the Risk of a Future Offense? Outsiders often obtain a substantial amount of information bearing on the firm’s future risk of causing them harm from the contents of the settlement agreement and the related public statements of the prosecutor and the firm that accompany its release. Yet we conclude in this section that outsiders are not likely to gain information bearing in the firm’s future risk of misconduct from the choice of settlement form—from the use of a plea instead of a DPA. Accordingly, we conclude that the decision to resolve a case through a plea instead of a DPA should not influence the cost of reputational damage to the firm, all other things equal.

We reach this conclusion after identifying and considering three possible ways in which the form of settlement conviction might affect interested outsider's beliefs about dealing with a firm in the future: direct revelation, prosecutorial selection, and management selection.88 We do not find support for any of these hypothesis. Rather than looking to the form of settlement, we expect interested outsiders to focus on the more probative information released at the same time they learn the form of settlement: the information released by the agreement about the offense, the offender’s relation to the offense, the sanctions, reforms, and any mandates imposed.89 Thus, there is nothing intrinsically more

88 Observe that the prosecutorial selection and managerial selection channels could not be used to support a policy favoring conviction in virtually all situations, as advocated by some (Uhlmann 2013), because conviction only produces an enhanced reputational cost attributable to prosecutor or managerial selection when prosecutors regularly select between conviction and DPAs, employing the latter for criminal settlements involving firms that are less likely to be repeat violators. By contrast, in a regime in which almost all firms are convicted, the decision to convict provides little information beyond that contained in the new release of the charges filed and the facts of the crime.

89 That is, the value to the outsider of the information about the form of the settlement is an incremental value that might be high if outsiders knew only the form of settlement, but is in reality low because the


stigmatizing about a corporate conviction given existing federal enforcement policy, if stigma is measured in terms of the reputational damage cost to the firm.

This conclusion begs the question of why firms appear to care about whether they are convicted. In response, we observe that there are reasons to expect that firms do not always care – at least not enough to agree to more onerous terms in order to avoid a plea. When they do care, it appears that the primary factor that motivates firms to resist a plea is if conviction could trigger collateral penalties that could reduce the firm’s expected profits in the United States or in other countries. Firms’ preferences for DPAs may derive from concerns about potential collateral consequences that could be imposed immediately or in the future. For example, a firm bear expected costs if it anticipates that it could be blocked from pursuing future business in a new jurisdiction that refuses to license or do business with firms that have prior convictions. As a result, such a firm might avoid conviction as a means of preserving such future business opportunities, all else equal, even in the absence of any U.S. collateral sanctions. This concern is distinct from a concern that conviction would trigger costs from reputational damage through the channels evaluated in this section.

Of course, some forms of collateral penalties—such as those imposed by many independent federal agencies—are a form of reputational damage cost. They are the process through which federal agencies may protect themselves, or the markets under their jurisdiction, from firms that present an excessive risk of harming others. Accordingly, in order to fully redress the question of whether conviction triggers—and is needed to trigger--greater reputational damage costs, we must next consider whether agencies that employ collateral penalties to guard against future harm predicate their decision to impose collateral sanctions on the simple fact of whether the firm was convicted or subject to a DPA.

5. Exclusion or Delicensing: Government Agencies as Interested Outsiders

In this section, we evaluate whether DPAs undermine the ability of government agencies acting as interested outsiders to react in their own interests to information revealed by the criminal settlement about the risk of future harm from dealing with a firm.

In federal criminal enforcement actions, the interested outsider may be a government authority, such as federal agency.90 Government agencies act as interested outsiders when they directly or indirectly purchase goods or services from a corporation, such as weapons and health care. Government agencies also act as interested outsiders

prosecutor and firm release so much other information to the public when they make the settlement announcement.

90 In addition, other government authorities, such as state governments, foreign governments, and non-governmental organizations (e.g., World Bank) can act as interested outsiders who may respond to news of a criminal settlement by exclusion or delicensing (e.g., Auriol and Soreide 2012; Hjelmeng and Soreide 2014).


when they are vested with the responsibility for protecting customers in particular markets (such as healthcare and public securities markets) by regulating firms’ to access to those markets. Government agencies acting as interested outsiders have an incentive to respond to criminal settlements that reveal information that the firm presents an enhanced risk of imposing heightened expected costs either on the agency as a purchaser or on the customers the agency was established to protect. Agencies’ potential responses to such news of interested risk generally include authority to exclude the firm from being able to deal with the agency or the markets it regulates. Thus, consideration of the cost of reputational damage to corporations for crime is thus not complete without considering the reaction of the government as an interested outsider to the settlement (see Alexander 1999).

In this Section we evaluate whether DPAs undermine agencies’ ability to respond, to efficiently protect their interests, to information released by a criminal settlement about a firm’s future risk of harming the agency or customers in markets for which it acts as a gatekeeper. We assume that, in their interested outsider capacity, agencies’ objectives are to reduce dealings with the firm if, but only if, two conditions are met. First, the criminal settlement reveals information indicating that the firm presents an enhanced risk of harming the agency as a purchaser or the customers it safeguards (see supra Section 3). Second, responses such as exclusion or delicensing are more efficient responses to this risk than alternative responses available to the agency, as discussed below.

Agencies’ reactions to settlements that indicate an increased risk of dealing with the firm require separate consideration because the options available to agencies when responding to a risk revealed by a criminal settlement differ from those discussed in Section 3. First, agencies often do not have full discretion over the decision whether to exclude a corporation revealed to present a high risk. Instead, many agencies’ decisions are governed by laws that identify the specific circumstances where the agency is entitled to exclude or delicense a firm; some laws mandate exclusion in certain instances (see infra 5.2). Second, agencies may be able to more efficiently respond to information that the firm presents a high risk by employing measures that preserve the relationship but reduce the firm’s future risk of misconduct. Specifically, many agencies have authority to require the firm to implement measures—such as corporate integrity agreements, enhanced reporting requirements, and outsider monitors—intended to deter future misconduct. These reforms impose costs on the firm and can thus constitute a cost of reputational damage, but the cost of reforms generally will be less than the cost of exclusion. Finally, agencies acting as gatekeepers for particular markets may more efficiently protect customers in those markets by releasing information about the firm, allowing customers to decide whether the benefit of dealing with the firm is worth the extra risk.

The question raised by critics of DPAs is whether prosecutors’ use of DPAs systematically undermines agencies’ ability to react to information revealed by a criminal settlement about the risk of future harm by excluding or delicensing the subset of firms whose past misconduct signals that they present a risk of future misconduct which is best


addressed by exclusion or delicensing, as opposed to through other interventions.

Our analysis of this issue proceeds in two stages. We first determine when an agency would exclude a firm with detected misconduct if it had discretion to decide, case-by-base, whether exclusion serves the agency’s interests. We assume that agencies would want to exclude only if two conditions are met. First, the criminal settlement or the agency’s own investigation must provide evidence that the firm presents a risk of future harm to the agency. Second, the agency can more efficiently protect its interests through exclusion or delicensing, than by relying on interventions such as required reforms to reduce the risk of future misconduct. We conclude that agencies with discretion would not exclude all, or even most, firms that enter into criminal settlement and find that agencies’ decision whether to exclude would not depend on whether the prosecutor settled through a guilty plea or a DPA.

We next examine how the choice of settlement form affects the exclusion decision of agencies constrained by laws that govern when they may and must exclude. We focus on whether, and if so how, the choice between guilty pleas and DPAs affects the agencies’ ability to exclude or delicense when, but only when, exclusion or delicensing more efficiently serves the agencies’ interests. We conclude that DPAs do not undermine, and indeed may enhance, agencies’ abilities to make exclusion decisions under these laws even though pleas trigger agencies’ exclusionary authority and DPAs do not. Although standard laws governing exclusion treat conviction, and not DPAs, as a trigger that can justify exclusion, resolution through a DPA does not undermine an agencies’ ability to exclude when it serves their interests to do so. Laws governing agencies’ authority to exclude convicted firms also typically grant the agency authority to exclude firms that the agency itself has found to have violated laws it is empowered to enforce. Thus, agencies can respond to criminal settlements that reveal that the firm harmed the agencies’ interests by proceeding directly to exclude the firm, should it wish to do so, whether or not the prosecutor convicts the firm or settles through a DPA. In addition, prosecutorial authority to use DPAs may be superior to requiring them to use pleas when the appropriate charges against the firm would trigger mandatory exclusion that the agency cannot waive, even when waiver serves its interests. In this context, under a plea-only policy, the prosecutor either must impose the charges that tie the agencies’ hands or alter the charges filed or the identity of the firm charged to avoid triggering exclusion.

5.1 How Agencies Would Approach Exclusion if Granted Full Discretion

If granted full discretion over whether to exclude or delicense a firm, an agency promoting its interests 91 would not necessarily exclude every firm that enters into a criminal settlement for misconduct that may implicate the agency’s interest. Instead, the

91 See text following note 90 for a discussion of our assumptions regarding the interests of agencies acting as interested outsiders.


agency would determine whether exclusion is warranted based its assessment of the firm’s risk of imposing costs on the agency (or the customers it is authorized to protect) based on information revealed by the criminal settlement. The agency can be expected to consider the factors discussed in Section 3, including information about the charges filed, scope and duration of the misconduct, harm caused, sanctions imposed, identity of the victims, sanctions imposed, and any voluntary reforms or mandates set forth in the settlement agreement or imposed by other sources. In evaluating these factors, it also may consider its private information about the offender and offense from its own investigation of the misconduct. As a result, the agency might not exclude an offender if it determines that dealing with the firm is not associated with an enhanced risk of harm, even after a high-profile conviction.

Moreover, even if the firm does present a heightened risk, the agency may decide that exclusion is not in its best interests if it can more efficiently limit the risks, and adverse effects, of a future offense without incurring the cost of excluding the entire firm. First, an agency with discretion might exclude a specific division, office or individuals. Alternatively, it may intervene to reduce the future risk of misconduct by encouraging voluntary reforms or using its own settlement agreement to impose mandates designed to deter future misconduct. Examples of mandates include corporate integrity agreements and monitors that the agency concludes are effective in reducing the risk of future misconduct.92 The costs of the reforms and mandates imposed by agencies as interested outsiders would be part of cost of reputational damage to the firm at settlement. Finally, agencies authorized to bar firms from dealing with customers in particular markets may conclude that it is more efficient to instead employ sanctions, reforms, and enhanced oversight to deter, along with disclosure to customers, thereby enabling customers to make their own decision about whether the expected cost of dealing with the firm exceeds the benefit.

The bottom line is that, in the absence of legal constraints, agencies would not always (or even often) exclude or delicense firms with criminal settlements that sell goods or services which provide a material benefit to the agency or customers. Instead, exclusion would be based on the risk of harm to the agency’s interests, signaled by the information about the factors identified in Section 3, revealed by the criminal settlement and, if relevant, the agency’s own investigation. Thus, the agency would focus on the underlying facts and not on whether the prosecutor entered into a plea or a DPA. Moreover, agencies would tend not to exclude a firm, even when the facts indicate the firm could present an increased risk

92 When agencies do intervene with exclusion, the cost to the firm may far exceed the value of the business directly lost as a result of debarment from dealing with the agency. Unlike private parties' reactions—which may remain hidden-- federal agencies' decisions to impose or waive debarment are publicly disclosed in their own decisions. They also may be publicly disclosed in the criminal settlement agreement. Disclosure of an agency’s decision to debar the firm based on an assessment of future risks, could impact other interested outsiders’ assessment of the expected risk of dealing with the firm, causing them to also refuse to deal with the firm.


to the agency’s interests, because they tend to prefer alternative solutions that impose fewer costs on the agency or customers, such as interventions that directly reduce the firm’s risk of future misconduct. In any event, agencies would not need prosecutors to resolve cases through a plea instead of a DPA in order to use exclusion or delicensing to promote their interests.

5.2. Laws Constraining Agencies’ Authority to Exclude

In actual practice, federal agencies generally do not have unfettered discretion to decide when and whether to exclude or otherwise restrict dealings with a firm. Instead, federal agencies tend to be required to deal equally with all firms that meet particular criteria. Statutes and regulations constrain the exercise of discretion over exclusion by determining when an agency can—or even must—exclude a firm found to have committed certain types of misconduct.

Statutory provisions governing exclusion vary from agency to agency. Nevertheless, they usually share some common features. First, provisions governing exclusion generally only allow agencies to exclude firms that commit a specific set of offenses. The list tends to include offenses that directly harm either the agency—such as submitting a false claim—or participants in the market the agency is authorized to protect. Some statutes also allow agencies to exclude firms sanctioned for certain offenses against other parties, such as fraud, whose commission could signal a risk of future harm to the agency itself.

Second, in most situations, even if a firm is convicted, agencies retain discretion over whether to exclude the firm. Many laws governing exclusion provide that all (or most) convictions implicating the agencies’ interests trigger permissive (and not mandatory) exclusion. Statutes providing for permissive exclusion tend to provide that the agency should exclude only when the firm both presents a risk of future harm and the risk is not better addressed through mandates, such as corporate integrity agreements and monitors.93 In cases of direct interest to the agency, agencies also tend to have discretion over whether to exclude should they prevail in their own enforcement action against the firm.

Finally, although many agencies are subject to provisions that mandate exclusion of firms convicted of particular offenses, many, if not most, agencies retain discretion to waive exclusion. Agencies often are encouraged to waive when the agency concludes the firm does not present a significant risk of future harm (see Velikonja 2015). Agencies with authority to waive can do so after the firm is convicted or they can agree in advance of the

93 For example, the provisions governing debarment by federal contracting officers provide that debarment and suspension should “be imposed only in the public interest for the Government’s protection and not for purposes of punishment.” 48 CFR Ch. 1 9.402 Policy. The list of factors to be considered in determining whether to exclude closely resemble the factors set forth in Section 3. Other agencies also consider the risk of future harm in evaluating both permissive exclusion and waiver of mandatory exclusion, and regularly waive mandatory exclusion (Velinkonja 2015).


plea that they will exempt the firm from exclusion. Nevertheless, some agencies are subject to mandatory exclusion provisions that limit their ability to waive exclusion. As a result, conviction of particular offenses could trigger mandatory exclusion whether or not the agency wants to exclude, unless the prosecutor adjusts the charges filed or the identity of the corporate defendant to avoid that outcome.94

5.2.1. An Example: Health and Human Services

To illustrate, it is useful to consider the rules governing when the Department of Health and Human Services can and must exclude a corporation that deals directly with the agency or patients following a criminal settlement. The governing statute provides that the agency only has authority to exclude if the firm is found to have committed a particular set of offenses. These include misconduct aimed directly at the agency (such as filing a False Claim with the agency) and the list of offenses that the agency is authorized to enforce directly. The types of misconduct potentially triggering exclusion include submitting claims for excessive charges or unnecessary services, engaging in fraud, kickbacks or other prohibited activities, knowingly making or causing to be made certain types of false statements, and a range of other offenses that bear on the entities’ suitability as either a government counter-party or a provider of services to patients. In addition, some other forms of fraud (such as False Claims against other agencies) may trigger permissive exclusion, but only under certain circumstances, discussed below (Social Security Act 42 USC § 1320a-7(a)(3) & (4)).

A firm detected with misconduct of the type described above can be excluded only if the firm was convicted of the offense or the agency determined on its own that the firm committed the offense (provided the offense is one that the agency has authority to enforce).95 Thus, while DPAs do not trigger HHS’s exclusionary authority, the agency generally can exclude a firm that settled through a DPA by proceeding on its own to establish that the firm committed the offense in most situations. , (see Social Security Act 42 USC § 1320a-7(a)(3) & (4)). There is only one situation where the choice between a plea and a DPA affects HHS’s ability to permissively exclude: where the firm is charged with fraud, embezzlement, or financial misconduct and related offenses with respect to a program, (other than a health care program), that is operated or financed by a Federal, State, or local government agency other than HHS.96 HHS can only exclude following a plea because the agency does not have jurisdiction over these offenses. In order to exclude, the

94 See infra text accompanying note 98.

95 The only offenses where the agency can permissively exclude if the prosecutor convicts but not otherwise are frauds against other agencies.

96 The statute permits permissive exclusion if the firm was convicted “(B) of a criminal offense relating to fraud, theft, embezzlement, breach of fiduciary responsibility, or other financial misconduct with respect to any act or omission in a program (other than a health care program) operated by or financed in whole or in part by any Federal, State, or local government agency.” Social Security Act, Section 1128B(f), 42 U.S.C. 1320a–7.


agency would need to determine that the plea signals that the firm has a future risk of harming health care programs, as explained below.

Determinations that trigger HHS’s authority to permissively exclude do not automatically, or even usually, lead to corporate exclusions. Instead, in line with the analysis in Section 5.1, HHS determines whether to exclude by assessing whether the firm presents a future risk of harm to federal health care programs. The risk assessment includes many of the factors discussed in Section 3. Of particular importance, mandates reforms can obviate the justification for exclusion. According to recent HHS guidance, exclusion “often” is not necessary if the wrongdoer agrees to “appropriate integrity obligations”—i.e., mandated reforms—or if a monitor would suffice to protect the agency’s interests.97 Thus, firms that agree to corporate integrity agreements or monitors can expect to avoid permissive exclusion even if they plead guilty.

There is one situation where the choice of settlement form has a material effect on HHS’s authority to exclude. The Social Security Act provides that felony conviction of a firm for either health care fraud or crimes relating to controlled substances triggers mandatory exclusion, whereas HHS’s own determination that the firm committed these offenses triggers permissive exclusion (Social Security Act 42 USC § 1320a-7(a)(3) & (4)). The statute also substantially restricts the agency’s ability to waive mandatory exclusion. The agency can only exempt a firm from exclusion if the agency determines both that the entity is the sole source of an “essential service in a community” and that exclusion would impose a hardship on the beneficiaries.98 In addition, the agency must determine that the exclusion would not be in the public interest (42 CFR 1001.1801). Moreover, even when a waiver is granted it is limited to the program (and the service) for which the waiver was granted. Thus, under these provisions, a convicted firm could end up excluded from selling most of its products to Medicaid beneficiaries, even if it is granted a waiver with respect to some of them. As a result, conviction can force the agency to exclude a firm that it would otherwise not exclude. By contrast, when such cases are resolved through DPAs, the agency can proceed against the firm itself and then determine whether to pursue permissive exclusion or use alternatives such as mandates.

Accordingly, analysis of the rules governing agency’s exclusion decisions reveals that these rules can constrain agencies ability to exclude when, and only when, exclusion serves its interests in two ways. In theory, they can restrict an agency from excluding a firm that presents a risk of future harm if criminal settlement did not contain a “triggering

97 See Criteria for Implementing Section 1128(b)(7) Exclusion Authority, Office of the Inspector General, Health and Human Services (April 18, 2016). https://oig.hhs.gov/exclusions/files/1128b7exclusion-criteria.pdf.

98 In restricting waiver to providers who are the “sole source,” and limiting waiver to the goods or services that it is the sole provider of, these waiver provisions appear to mandate exclusion in a broader range of situations than would trigger exclusion if the agency had full discretion and followed the analysis outlined in Section 5.1. supra.


event.” Second, the criminal settlement can cause the agency to exclude a firm even when, the agency acting as an interested outsider would determine that exclusion does not serve the agencies interests because the firm does not present either a risk of future harm or one that is efficiently addressed by exclusion.

The question to be considered is whether, in light of the standard constraints placed on agencies’ authority over exclusion, agencies are better able to serve their interests by excluding those firms when, but only when, the firm presents an enhanced risk of misconduct more efficiently addressed by exclusion.

5.3. Do Guilty Pleas or DPAs Better Facilitate Efficient Exclusion

In this part we evaluate whether agencies are better able to use exclusion to promote their interests as interested outsiders when prosecutors resolve many, if not most, cases through DPAs or under a regime that requires prosecutors to resolve almost all cases through a guilty plea. To address this question we limit ourselves to the subset of offenders and offenses that potentially implicate exclusion. For all other crimes, the use of DPAs has no effect on agencies’ decisions whether to exclude. We first consider the effect of the choice on the set of crimes that trigger permissive exclusion. We then consider mandatory exclusion, beginning with agencies with full waiver authority, and the moving to those with constrained authority to waive mandatory exclusion.

5.3.1. Pleas That Trigger Permissive Exclusion

As previously explain in Section 5.2, regulations governing exclusion grant agencies authority to decide whether to exclude a firm only if the firm committed one of a particular set of offenses. The core set of offenses that trigger exclusion are those that directly implicate the agency’s interests as an interested outsider; these offenses also are the ones the agency has jurisdiction to enforce (see supra Section 5.1). In the case that these core offenses trigger permissive exclusion, the agency’s authority to exclude is not undermined, or even altered, by the use of a DPA instead of a plea. Statutes granting permissive exclusionary authority when a firm is convicted of such offenses also generally allow the agency to seek permissive exclusion even absent a conviction, following a determination by the agency that the firm committed the offense. Thus, for these core offenses, resolution through a guilty plea does not open a door leading to potential exclusion that the agency could not open on its own following resolution of the case through a DPA.

Of course, it might at first appear that agencies can better employ exclusion to protect themselves from high risk firms when prosecutors employ pleas because the plea relieves the agency of the burden of pursuing its own action to find that the agency committed misconduct. Yet this is not the case. The guilty plea saves the agency from having to make the initial determination that the firm engaged in the misconduct in question. Yet, whether or not the firm entered into the guilty plea, the agency still must


employ a formal process to determine whether exclusion is appropriate. Moreover, the determination of whether exclusion is appropriate does not depend on the choice of settlement form. Instead, it generally depends on a factual assessment of whether the firm presents an increased risk of harm best addressed by exclusion, in light of considerations such as the nature and scope of the misconduct, the effectiveness of the firm’s compliance program at the time of the crime, whether the firm self-reported and fully investigated the misconduct, whether the firm has sanctioned individuals responsible for the misconduct, and whether the firm has undertaken voluntary reforms of its internal governance (see, for example, provisions governing debarment of government contracts, 48 CFR Ch. 1 9.406-1). Thus, whether or not a case settles through a plea or a DPA, crimes that trigger permissive exclusion will result in the agency predicating exclusion on factors bearing on the firm’s risk of harming the agency’s interests in the future, and not on the choice of settlement form.

Moreover, whether or not the case is resolved through a plea or a DPA, the agency can be expected not to exclude if it concludes it can employ alternative measures to reduce the firm’s future risk of misconduct that impose lower costs on the agency’s interests. Consequently, even when a firm has plead guilty, agencies tend not to exclude if the agency concludes that the firm’s risk of future misconduct can be adequately addressed by mandated internal governance reforms or monitors (see supra Section 5.2). The agency’s interest in considering alternatives to exclusion or delicensing are particularly great when exclusion would deny the agency or the public access to valued goods and services, as is likely with high profile firms.99 The observation that agencies tend to prefer mandates to exclusion in these cases has particularly relevance for the concern of DPA critics that DPAs weaken the cost of reputational damage imposed on high profile firms. Firms entering into DPAs usually adopt voluntary reforms and enter into agreements imposing mandated internal governance reforms (Alexander and Cohen 2015; Arlen and Kraakman 2017). This willingness to accept mandated reforms may be expected to lead an agency acting as an interested outsider to address any concerns through mandates reforms rather than exclusion even if the firm were required to plead guilty to charges triggering permissive exclusion.

Of course, a prosecutors’ decision to employ DPA instead of a guilty plea will preclude permissive exclusion by some agencies in a particular set of cases. Some agencies, for example HHS, can exclude a firm that defrauded a different government agency but only if the firm was convicted (see supra Section 5.2.1.). Resolution of such cases through a DPA precludes exclusion by such agencies (though the victim agency may be able to exclude). Yet this only undermines agencies’ ability to serve their interests as interested outsiders if they would be likely to exclude in such cases. We expect that this is unlikely.

99 Agencies considering exclusion that would preclude firms from dealing directly with certain customers (e.g., patients) also will evaluate whether, following disclosure of the misconduct (and any mandated reforms), it would better serve the agency’s interests to allow the firm to deal with any customers who continue to want to do so.


First, an e agency is unlikely to consider exclusion unless the misconduct against the other government authority also signals that the agency in question faces a risk of future harm. This will depend on considerations that may include the effectiveness of the firm’s compliance program, whether the agency deals with the unit of the firm responsible for the offense, and the agency’s assessment of senior management (see supra Section 3). Second, the agency is unlikely to exclude if any risk of future misconduct has been addressed by either voluntary reforms or mandates imposed by the criminal settlement agreement.100 Thus, while the choice to use a DPA could affect a few cases, it appears likely that most would not lead to exclusion even if the firm were convicted.

Consequently, the choice of settlement form for criminal settlements for charges that can result in permissive exclusion should not affect the agency’s decision to exclude the firm. In either case, the agency generally will have authority to exclude. In either case, the agency will predicate the exclusion decision not on the choice of settlement form, but instead on an assessment of the underlying facts about the crime and the firm indicative of the firm’s future risk of misconduct (see Section 3). Finally, following either resolution, the agency has an incentive to resist exclusion, even if it perceives a heightened risk of harm, if it concludes that the risk can be more addressed more efficiently through reforms designed to deter future misconduct.101

5.3.2. Pleas that Trigger Fully Waivable Mandatory Exclusion

The conclusion is similar in situations where the firm is charged with misconduct that would trigger mandatory, but fully waivable, exclusion if the firm enters into a guilty plea. The reason is that statutes providing for mandatory exclusion for particular offenses also grant the agency permissive authority to exclude, even absent conviction, based on its own determination that the firm engaged in the misconduct (see discussion Section 5.2). In addition, the central consideration bearing on whether the firm should or should not permissively exclude—the firm’s risk of a future offense—also is the central consideration bearing on whether an agency should exempt a firm from exclusion that was (or would be) automatically triggered by a guilty plea (see, e.g., Velikonja 2015 discussing exclusion waivers).

100 In addition, in theory, an agency that concluded that the firm presents a significant risk to itself, may be able to signal to the prosecutor that the public’s interests would be best served by a guilty plea—although we are not aware of situations where agencies have sought to debar a publicly-held firm based on harms to other agencies.

101 This is evident from our earlier examination of the Social Security Act. The Act empowers the Secretary to seek permissive exclusion even if the firm was not convicted of a crime if the Secretary determines that the firm engaged in fraud, false claims, bribery, kickbacks or other offenses relating to health care. The Secretary has authority to make its own determination about whether key civil or criminal laws relating to health care were violated, and to impose permissive exclusion should it determine they were. Indeed, the Secretary’s authority to seek exclusion extends beyond violations that impose substantive harms to the firm’s decisions to violate various duties to provide timely and accurate information, and similar types of misconduct arguably going to the firm’s probity.


Of course, the choice between a DPA and a plea does affect who bears the burden of proof in these cases: a plea triggers exclusion unless the firm can establish that exclusion is unwarranted. Whereas, following a DPA, the agency would need to establish that exclusion is warranted. The burden of proof could matter when the evidence does not strongly indicate that the firm presents a high or low risk of future misconduct. Yet these are the cases where the choice of settlement form is least likely to have an effect. The net expected benefit of exclusion is lower the weaker the evidence is that the firm presents a risk of future harm to the agency’s interests. Accordingly, in these borderline cases, the agency has a particularly strong incentive to address potential increased risk through mandated reforms, instead of exclusion.102 Thus, even though pleas shift the burden of proof, agencies may not respond by increasing the use of exclusion since mandated reforms are likely to be viewed as preferable in those cases where shifting the burden of proof could matter.

Accordingly, we conclude that the choice of settlement form is unlikely to have a material effect on the decision to exclude by agencies that would have discretion over whether to exclude the firm should it be convicted.

5.3.2. Pleas that Could Trigger Mandatory Exclusion That is Not Generally Waivable

We now consider the subset of cases where a plea would trigger “mandatory” exclusion that the agency does not retain sufficient discretion to waive. The most obvious example are felony convictions for health care fraud or false claims brought against pharmaceutical firms. In this situation, the agency would have discretion to exclude the firm if the prosecutor enters into a DPA, but could be required to exclude if the firm enters into a guilty plea (see supra Section 5.2, explaining when waiver is possible). DPAs enable the agency to exclude when, and only when, the agency determines exclusion serves its objectives.

The use of pleas obviously increases the rate of exclusion in such cases because pleas mandate exclusion whereas exclusion is discretionary following a DPA. Yet fact is not a consideration weighing in favor of requiring pleas unless granting the agency discretion provides little if any benefit because exclusion is the best outcome in all these cases. This implies that pleas are preferable in such cases only if agencies would most efficiently serve their interests by excluding whenever a firm is convicted of an offense triggering exclusion. There are good reasons to conclude that this condition is not met.

102 Indeed, to the extent that the transactions costs of exclusion decisions differ following pleas and DPAs, it is far from clear that the difference should favor pleas. While it is true that a plea shifts the burden of establishing waiver to the firm (potentially lowering the agency’s costs), the overall transactions costs of criminal settlement through a plea may be higher when conviction triggers waivable mandatory exclusion because the firm will likely refuse to settle with a plea unless the relevant agencies agree not to exclude it. The transactions costs of obtaining the needed waiver can be particularly high if the firm could be debarred by multiple federal and state agencies if convicted, necessitating the need to obtain ex ante commitments not to exclude from each one.


Agencies serve their aims as interested outsiders through exclusion only when misconduct signals that the firm presents a future risk of harm to the agency. Yet, as explained in Section 3, even when a firm committed misconduct against an interested outsider, the firm may not present a high risk of harming the outsider in the future for a variety of reasons. For example, an agency would be unlikely to anticipate a high risk of future harm from a firm convicted for fraud by a single (since terminated) individual that was promptly detected by the compliance program and reported to the agency (see supra Section 3). Agencies’ interests are served by discretion not to exclude in such situations—discretion available following a DPA. In addition, even if the firm would otherwise present an enhanced risk of future harm, agencies tend to prefer to use mandated reforms and monitors to address this risk, rather than exclusion, as these impose lower costs on the agency or those it serves. Accordingly, to the extent that agencies generally prefer not to exclude, agencies’ abilities to achieve an efficient outcome with respect to exclusion is better served through the use of DPAs, that leave the agency empowered to exclude if (but only if) it so chooses, than a plea which would likely require the agency to exclude a firm that it might not want to. Pleas, by contrast, impose costs because they may require an agency to exclude when its objectives are better served by not excluding.

Additionally, a rule requiring conviction would not necessarily lead to more exclusion of firms in situations where a guilty plea against the firm for the misconduct committed would trigger mandatory exclusion that the agency would prefer not to impose. In such situations, a prosecutor may have an incentive103 to alter either the charges filed or the identity of the firm charged to avoid entering into a plea that triggers mandatory exclusion of a firm providing valuable goods and services. For example, prosecutors can avoid triggering mandatory exclusion by altering the charges filed to favor crimes, such as misdemeanors, that will not trigger mandatory exclusion. For example, in the health care context, the prosecutor could charge the firm with a misdemeanor instead of a felony; or seek a basis for charges other than health care fraud, controlled substances or patient abuse or neglect. Alternatively, prosecutors can enter into a plea for charges that trigger exclusion with a relatively unimportant subsidiary, and not the parent corporation responsible for the misconduct, to ensure that mandated exclusion only falls on the subset of the firm’s activities located in the subsidiary.104

103 This prosecutor may have an incentive to alter the charges to settle the case, if the firm makes a credible threat to go to trial rather than accept a guilty plea that would trigger mandatory exclusion (see Section 4.2.3. supra). Alternatively, the prosecutor might alter the charges to avoid mandatory exclusion at the request of the agency or to avoid harming innocent customers, in keeping with policy concerns expressed in the USAM.

104 For an example of this approach, see also the guilty plea entered into against Pfizer Corporation. According to the press release “Pfizer” plead guilty but the guilty plea in fact was with a Pfizer subsidiary whereas the Pfizer, the parent company, entered into a pretrial diversion agreement. https://www.justice.gov /opa/pr/justice-department-announces-largest-health-care-fraud-settlement-its-history. For discussion, along with empirical evidence on the different frequencies with parents and subsidiaries enter into DPA and plea


When this occurs, there are two effects. First, these adjustments insulate the firm in question from exclusion, notwithstanding the use of a guilty plea. Second, as a result of these adjustments, the prosecutor also has to alter the information contained in the criminal settlement to support the charges filed against the firms that were charged. The possibility arises that the net effect could lead to guilty pleas leading to lower cost of reputational damage imposed by interested outsiders on corporations if the information released by the guilty plea indicates that the parent corporation was less responsible, or committed a less serious offense, than would have been revealed had the firm entered into a DPA.

5.4. Summary

Accordingly, even though conviction for an offense may trigger an agency’s authority to exclude whereas a DPA does not, we conclude that a prosecutors’ decision to employ a DPA instead of a plea does not undermine agencies’ abilities to obtain exclusion when they would otherwise have exercised discretion to exclude in the event of a guilty plea. First, the use of DPAs does not undermine the agency’s exclusionary authority when conviction would trigger permissive exclusion, because the agency also generally has full authority to exclude should it conclude exclusion is appropriate following a DPA. Moreover, following both types of settlements the agency often can be expected to address any perceived future risk through mandates rather than exclusion. Second, when conviction would trigger mandatory exclusion that the agency is not free to waive, agencies may be better off under DPAs because DPAs relax constraints on the ability of the agency to obtain exclusion only when exclusion serves its interests, and not otherwise. Requiring pleas would then undermine the agency’s ability to achieve its objective, by either requiring it to impose an exclusion that does not efficiently serve its interests or by incentivizing it to seek adjustments to criminal settlements to avoid triggering mandatory exclusion. Accordingly, a policy requiring prosecutors to favor a plea would not lead to a decline in the cost of reputational damage in the public interest in those cases where an agency of government is the interested outsider.

6. Conclusion

U.S. prosecutors entering into criminal settlements can either seek to require a firm to plead guilty or offer to resolve the matter through a DPA. Prosecutors can impose the same formal sanctions through DPAs as through guilty pleas: the same charges, statement of facts, monetary sanctions, and mandates. Nevertheless, a debate has persisted over whether DPAs undermine deterrence by lowering the cost to firms of the reputational damage resulting from a criminal settlement.

In this chapter, we undertook an assessment of the view that criminal settlement through a guilty plea instead of a DPA causes firms to bear higher costs from reputational

agreements as signatories see Alexander and Cohen 2015.


damage, holding all else constant. To assess this claim, we first identified the types of qualitative information released by corporate criminal settlements that could lead interested outsiders—e.g., customer and suppliers—to anticipate an enhanced (or reduced) risk of harm from future dealings the firm. This includes information about the crime, the corporation’s governance at the time of the crime, and post-crime reforms and mandates. We then showed that settlement through a plea could heighten the cost of reputational damage if it directly or indirectly leads interested outsiders to obtain information that the firm has a heightened risk of future misconduct that they would not obtain from a DPA settlement. We conclude that this requirement is not met after examining the three potential channels through which pleas might possibly transmit different qualitative information about the firm’s future risk: direct revelation, prosecutorial selection, and managerial selection.

Our conclusion that pleas and DPAs not only impose similar formal sanctions but also lead firms to sustain similar costs from reputational damage of course raises the question of why firms care about whether they are required to plead guilty. Our simple answer is that firms are likely to care only to the extent to which a guilty plea would subject them to an enhanced risk of exclusion or delicensing, by a federal, state, local or foreign government agency immediately or in the future.

The potential impact of guilty pleas on exclusion is not an independent reason to prefer them, however. Federal agencies can best serve their interests as interested outsiders by excluding or delicensing firms entering into criminal settlements when two conditions are met: first, the criminal settlement reveals that the firm presents an enhanced risk of causing future harm to the agencies’ interests and second this risk cannot be more efficiently addressed by mandated reforms instead of exclusion. Thus, agencies granted full discretion over exclusion would not exclude every—or even most—firms convicted of an offense. Instead, they would predicate exclusion on information about the firm’s future risk of misconduct and on the potential to address this risk through mandated reforms. Pleas do not promote agencies’ interests because agencies with exclusionary authority generally can exclude following a DPA based on their own findings. Moreover, those agencies required by law to exclude firms convicted of certain charges may better serve their interests as interested outsiders when prosecutors employ DPAs than pleas because DPAs leave them free to use permissive exclusion and enable them to exclude when, but only when, appropriate.

Finally, we have provided a framework for evaluating the effect of the form of settlement on the costs of reputational damage from a criminal settlement in terms of the reactions of interested outsiders to the qualitative information released at settlement, including information about reforms and mandates. First, by identifying the types of information, including information about aggravating and mitigating circumstances that may affect outsiders’ willingness to deal with the firm in the future. Second, by specifying the channels through which the choice of settlement form—here plea vs DPA but also


potentially criminal and civil—would affect the cost of reputational damage by altering the information that is directly and indirectly available to interested outsiders about the risk of future misconduct. Finally, we distinguish the dynamic effects of reforms and mandates from other effects of settlement.


Figure One Interested Outsiders’ Decisions that Affect the Cost of Reputational Damage

Figure 2

Candidate Indicators of Risk of Future Harm to Interested Outsiders

Information about the Crime Information about the Firm

Nature of the Crime

Did crime harm counter-parties

Magnitude of harm

Number of charges

Duration of crime

Nexus to Outsider

Geographical or subject-area distance between wrongdoers and locus of outsiders' dealings with firm

Number of different offices implicated

Seniority of wrongdoers

Causes of Crime

Compensation policy induced crime?

Managers involvement

Quality Training

Effectiveness of compliance program

Managers detect and intervene?

Wrongdoers terminated?

Broader Governance

Quality of employee training

Resources for compliance program

Quality/seniority of compliance officer

Evidence Director Oversight

Quality Post-crime Reforms

Mandated Reforms

Mandated Oversight

Information in Agreement Signals that Firm Has Heightened Risk of Causing Future Harm to Interested Outsiders

No

Yes

Interested Outsiders Can Refuse to Deal with Firm or Adjust Terms

Yes Firm Can Costlessly Eliminate Increased Expected Risk

No

Firm Does Not Bear Cost From Reputational Damage as a Result of Criminal Settlement

Firm Bears Cost From Reputational Damage Following Criminal Settlement

Yes

No


Figure 3

Figure 4

Federal Policy & Prosecutors' Objectives

Factors that Favor a Plea

Indicators High Risk of

Crime

Guilty Plea

Prosecutor Observes Hidden Information

DPA

Inference high risk

Prosecutor Observes Hidden Information

Federal Policy & Prosecutors' Objectives

Factors that Favor a Plea

Guilty Plea

DPA

Indicators High Risk

Collateral Consequences


Table 1

Selected Governance Reforms and Mandates

in DPA and Plea Agreements with Public Corporations 2003-2011

DPA (65)

Plea Agreement (Conviction) All* (321) All (167) USAM (77)

Compliance and audit program revisions

95% 33% 52%

57%

(62) (54) (40)

(183)

Hotline or ombudsman 49% 12% 22%

28%

(32) (20) (17)

(91)

Training

77% 28% 48%

46%

(50) (47) (37)

(149)

Business unit shut down or divested

14% (9)

1% (1)

1 (1)

6% (19)

Other business changes 26% 16% 1

2%

Other business changes

(17) (13) (1)

(5)

Debarred or suspended - 3% 6%

2%

Debarred or suspended

(0) (5) (5)

(5)

* The total (All) is the sum of DPA and All Plea Agreements from a sample of 321 agreements with available signed settlement documents, 2003-2011. USAM Plea Agreements exclude antitrust and environmental convictions. The source is hand collected data from 486 settlement agreements between the US Department of Justice (including USAOS) and public companies, 1997-2011, by the staff of the Law and Economics Center GMU with support from the Searle Civil Justice Institute. NPAs are excluded. See Alexander and Cohen (2015) for detail on the sample, sample selection procedure, and variable definitions.


Appendix

Illustration using a Basic Model

We extend the basic model of Darby and Karni (1973) to illustrate how the form of criminal settlement may affect the cost to a firm of reputational damage resulting from detected corporate crime.105

In the illustration, the interested outsider is a potential customer and the crime is fraud. In the basic model, the seller faces a cost of reputational damage from the misconduct. Our extension reveals how a settlement might enhance the cost of reputational damage and thus promote general deterrence.

Consider a firm that sells a repair service, such as car repair, where the total amount of services provided is given by S. Assume that the producer knows the expected level of services that the consumer needs to achieve her objective (a repaired car), which is given by Se. The consumer benefits from services up to Se and derives no benefit from services over Se. We assume that production costs are given by C(S) where C′(S)>0.

Although the producer knows the level of service needed by the consumer, the customer does not. The customer can observe services provided and charged for, but does not know whether they exceeded the level, Se, needed to achieve the customer’s objective (e.g., having her car repaired). The firm thus can provide services over and above those that provide any value to the customer: S = Sd + Se. We normalize the customer’s preferred level of service to zero, so that Se=0. As a result, S=Sd, and S denotes the delivery of excessive service. The only way to avoid the delivery of excessive service is to recommend, and provide, no service at all in this case. The seller charges a price PS, that is an increasing function of the recommended service level S. The customer accepts the offer. Fraud occurs when the firm knowingly over charges the unsuspecting customer by providing services that are not needed to achieve the consumer’s stated objective (e.g., to repair the car). The harm to the customer is the over-payment that occurs relative to the payment that the seller would extract from a fully-informed customer, and is given by PS.

The customer cannot detect fraud ex ante but may detect it after the fact. For example, the customer may subsequently seek services from a new firm and learn about the fraud. The probability of detection is assumed to be a function of the magnitude of the fraud—the greater the excessive services the more likely the customer will seek additional information on the services provided and detect the fraud. Should the customer detect the fraud, she is unlikely to do business with the firm in the future. She also may tell other consumers.

Absent legal sanctions for fraud, the firm’s incentive to engage in the fraud is

105 An extensive literature has emerged to explore the mechanism through which fraud and related bad-news events triggers a reaction by outsiders, along with the practical implications, dating to Darby and Karni (1973). For recent examples, see Board and Meyer-ter-Vehn (2013) and MacLeod (2007).


constrained by the cost to the firm of the loss of future business should fraud be detected in addition to the cost of providing the excessive service. The cost to the seller of reputational damage is the cost of customers’ reaction to the detected over-charging. This includes both the loss of the victimized customer (purchaser) and the loss of business from other customers who learn about the fraud and react in the same way. The value of an individual purchaser’s future business that could be lost if the purchaser detects fraud is given by V. The total value of all business that could be lost is kV, where k=1 if only the purchaser knows of the fraud and k>1 if other consumers have access to the information and knowledge of the fraud is more widely dispersed, as discussed below.

In the Darby and Karni model, consumers can detect some frauds; the probability of detection is an increasing function of the magnitude of the fraud, S. The firm’s expected payoff from fraud is thus given by:

|

where kV is the value of future business to the firm obtained if fraud is not detected, which

occurs with probability ( | ).106 Thus, | is the firm’s ex ante

expected cost of reputational damage from fraud of magnitude S. p | denotes the probability that consumers will detect the fraud and take their future business elsewhere, which is increasing in S, so that / >0 (i.e., p’>0) with p | . p | also depends on the quality of the information about the fraud that the consumer receives in

the sense that that ⁄ >0. Absent legal sanctions for fraud, it is assumed that the consumer only detects if S is large enough to cause him to investigate, or if some other defrauded consumer detected and informed him.

Firms select the magnitude of deception at the point where the marginal cost of the enhanced risk of detection and related loss triggered by more deception equals the marginal benefit of the increased revenues. Firms defraud consumers because fraud is costly to detect and prevent in equilibrium (Darby and Karni 1973).

In our extension of the model, we make explicit two channels through which criminal enforcement can affect the cost to firms of reputational damage from fraud.107 First, a criminal settlement can improve the quality of the information that consumers receive about the harm from the fraud (higher ) and thereby increase their willingness to take their future business elsewhere in response to those frauds that are relatively more

106 To the extent consumers view S as a signal of fraud then firms also will treat as a cost of fraud the reduction in the probability of selling the first unit resulting from a fraud large enough to lead consumers to decline the first unit on suspicion of fraud. In terms of the model, an increase in the magnitude of the fraud S can lead to a decline in the probability of completing the initial sale F(S), which we assume to equal one and be invariant to S.

107 In addition, criminal settlements can affect the cost of reputational damage by imposing mandates reforms that affect outsiders’ expectations about the future risk of misconduct. See supra Section 3.4.


harmful (higher p’). For example, a consumer who received a large bill can learn as a result of the criminal settlement either that his specific bill was for unnecessary services or that the firm charged other consumers for unnecessary services, thus increasing the probability that the high S the consumer was charged was for unnecessary services. The disclosure eliminates uncertainty about whether, by avoiding the firm, the consumer can avoid future harm (see Section 3.2 supra).

Second, the criminal settlement can disseminate information more widely than would otherwise occur, represented here as an increase in k.108 For example, the criminal settlement for fraud may trigger discussion of the fraud in the media, disseminating the revelation of the firm’s practices to consumers nation-wide or globally. The effect is to increase the cost of lost future business to the company from the customer reaction (higher kVp′). To illustrate the effects of a change in the enforcement environment on the amount of fraud in equilibrium, we consider the case where is convex in S and the choice is an interior optimum.

The seller’s decision of what services to provide ∗ is characterized by the first-order condition of the model: ’ ∗ . As Darby and Karni point out, the marginal return to over-charging must equal the cost of the resulting loss of sales, which is here limited to the expected loss in future sales. That is, if firms face only the threat of consumer reaction and no formal legal sanction from over-selling, we have:

’ ∗ = P – C′ – ′ ∗| ) = 0

The incremental cost of reputational damage or stigma from the fraud is the last term in the above expression. It is the expected cost of the lost future sales that the seller anticipates from the increased chance that the purchaser (and other similar customers) will take their business elsewhere (higher p) upon detection of the fraud. p ′>0 is thus a necessary condition for the expected cost of reputational damage or stigma to deter the misconduct. The cost of the customer reaction depends on the value of the lost customer business to the seller (kV).

In this model, the effect of the criminal settlement is to increase the expected cost of fraud by increasing the quality of information that the victim receives and thus the probability that the defrauded customer both detects the fraud and responds by refusing to

deal in the future: ′ / / = ∙ / < 0. The settlement can further increase the cost to the firm by increasing outsider access to the fraud news and thus the number of other customers who learn about the crime and respond by taking their

108 We introduce the parameter k (outsider access) to highlight the effect of increasing the number of interested outsiders who receive a signal of the bad act. For simplicity, we model the outsiders as having the same information and incentives as the initial purchaser. To explore heterogeneous reactions across outsiders, one could alternatively write, ∑ | ), thus letting k = ∑ | / | ]. Allowing for such heterogeneity does not affect our conclusions, and we do not further explore it here.


business elsewhere: ′ /k / ′ . These effects separately and together decrease the seller’s optimum level of fraud. That is, by application of the implicit function theorem at the optimum, dS*/dk, dS*/d < 0.

To summarize, using a simple model to illustrate, we have identified distinct channels through which information about an episode of misconduct can lead a firm to sustain a cost of reputational damage or stigma. A necessary condition in each instance is that the seller anticipate an increase in the probability of lost future business (or its expected amount) as a result. Interested outsiders who are prospective customers or counterparties must gain knowledge of the fraud and, based on this knowledge, be willing to take their future business elsewhere with some positive probability, as indicated in Section 3.2. Differences in enforcement regimes can by influencing the information obtained by interested outsiders – through enhanced quality or access– cause differences in the cost of reputational damage or stigma to the offending firm, accordingly.


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