May 7, 2012 Bill Bratton
Chris Brummer, Soft Law and the Global Financial System: Rule Making in the 21st Century (Cambridge University Press 2012).
Every once in a while I read something and say to myself “this one’s a keeper” in the sense that it goes to the shelf to be drawn on again as an important source of knowledge. This book earned that status early in the read and it earned it again and again as the read went on. Indeed, I may be this book’s ideal reader for the very reason that I’m a domestic business law academic. To be sure, the book follows from and addresses a number of international law literatures and so addresses itself in the first instance to the international legal cohort, both to international law writ large and the group’s business and financial subset. But the learning curve is much steeper for me than for those primary addressees. Here we find the whole cast of international financial characters–bankers, cops, securities and insurance regulators, auditors, politicians, bureaucrats, technocrats, and their international and domestic organizations–all carefully and neatly laid out with their histories, structures, and outputs juxtaposed and categorized. My revelation lay not in the fact that I’d never heard of them (although I must admit that one or two were new to me), but in the fact that my institutional knowledge was full of holes, particularly as regards the book’s comparison to other, treaty-based international organizations.
When I picked up the book I wrote down three general observations, touchstone points to assist in evaluation. They are:
- Globalization implies downward regulatory pressure.
- Soft law will always disappoint you.
- Reputational sanctions are unreliable.
First, globalization and downward regulatory pressure. More particularly, what’s the interface between the book’s account and regulatory competition–race to the top, race to the bottom, law as product, or whatever you want to call it? In fact, there’s not much in the book about downward competitive pressure. It’s more a background factor that pops up on the screen when pertinent. Even so, I think it’s an important part of what the book is about. I think back fifteen years or so to a discourse that posed international regulatory competition as against international regulatory co-ordination. The competition side of the binary was heavily theorized where the co-ordination side was not. The competition side drew on economic theory going back to Tiebout and had negative things to say about co-ordination, which it cast as rent seeking. There wasn’t a whole lot on the coordination side. Since then international lawyers have been slowly filling in the picture. This is where I locate the book. For me it fills in the empty set with an exhaustive description of the international co-ordinative effort. Theory can now start over.
Second, soft law will always disappoint you. The book does nothing to refute this assertion, even as its author makes his enthusiasm for soft law abundantly clear. Herein lies another source of value. Although soft law will always disappoint, there’s no point in railing about its softness when it’s all you’re going to get. And, says Brummer, international soft law is harder than you think. The key lies in the capaciousness of the soft law set described. It is not just IOSCO, or BIS and Basel. It’s not just the G-20 plus the FSB. It’s all of them plus the cops at the Financial Action Task Force (who appear to be pretty good at beating up on rogue states), the nasty lenders at World Bank and IMF, and the triumphant standard setters at the IASB. The cohort, taken as a whole, held out more than enough to reckon with before 2008 and since then it has been very much in motion. The book’s last part is a tour de force that shows the system in action, sector by sector, in the wake of the financial crisis. No, these regulators have not solved the problem of systemic risk. And, yes, their regulatory output very much follows from national-level initiatives. But national level reforms are all the stronger in light of the cross-border supplement.
Third assertion: Reputational sanctions are unreliable. This is a point I learned back in the 1980s when American management breached what the law and economics people called “implicit contracts” between corporations and constituents like labor and creditors. Implicit meant unenforceable at law but to some extent binding in practice. But the glue came from reputation and management overnight threw out reputational stakes built up across several decades as costs and benefits changed in a dynamic environment. So I brought a bottomless store of skepticism to the book’s positive case for the binding impact of reputational stakes in international soft law. I accept the book’s positive case at face value–a constraint is indeed in place. But for me that only opens the bidding. That said, I note that the book is unremitting in its discussion of systemic shortcomings. Although it manifestly makes a case, it does not over-claim.
So if you know all sorts of things about international finance but the entirety remains murky for you, get yourself a copy of Chris Brummer’s book. Pronto.
Mar 9, 2012 Robert Rosen
Jennifer Arlen,
The Failure of Organizational Sentencing Guidelines, 66
U. Miami L. Rev. 321 (2012), available at
SSRN.
Many are claiming that the market for legal talent is undergoing fundamental transformation. If so, there are undoubtedly multiple causes, at the least because the legal market is a highly differentiated one. In the individual and personal plight sector, user-friendly consumer interfaces and legislative and judicial restrictions on access to justice are of importance. In the corporate sector, intelligent search engines, outsourcing and the internalization of legal work are of importance.
Today’s changes in the corporate sector of the legal profession, in my opinion, mirror the changes in the engineering profession at the beginning of the last century. The basic story is that engineering was once a liberal profession, marked by engineers working in engineering firms. Now, although engineering firms still exist, by and large, engineers work inside corporations. In this transformation, engineers, like lawyers today, lost the monopoly rents which they were able to extract in market transactions between professional firms, which largely controlled elite expertise, and corporate organizations.
To prosper, and to secure jobs for engineering graduates, engineering was forced to redefine what work within the corporation was within engineering’s jurisdiction. To minimize conflict, the profession articulated how engineering work was to be controlled inside the corporation. And to regain professional status, engineering graduates became general managers.
Engineering did not only play defense. Organizational engineering emerged, most famously as espoused by Frederick Winslow Taylor, who had trained as a mechanical engineer. Later, safety engineers, product safety engineers, and security engineers, among others, became career paths within corporations and job choices for those who entered engineering school. Playing offense, the engineering profession secured more corporate jobs for its graduates than had been available to it as a liberal profession.
Read against this background, Jennifer Arlen’s The Failure of Organizational Sentencing Guidelines, 66 U. Miami L. Rev. 321 (2012), marvelously explains why change in how lawyers serve corporations is necessary and suggests an offensive strategy. In this article, Professor Arlen continues her earlier work demonstrating that the Organizational Sentencing Guidelines have failed to reach their goal of deterring corporate misconduct and begins to explain how organizational compliance programs can be better designed to detect, report, and respond to non-compliance.
As Professor Arlen has demonstrated previously, sanctions will not deter corporate crime, because sanctioning the organization doesn’t necessarily sanction the responsible individual and the responsible individual is difficult to detect because the organization is relatively opaque from the outside. Instead, “corporate policing” is required. For large corporations this creates a challenge: How to design and implement effective compliance programs?
In this article, Professor Arlen focuses on the perverse effects of the Organizational Sentencing Guidelines on corporate policing. The Guidelines mitigate punishment for those corporations which have adopted compliance programs. But the guidelines fail to adequately take into account the increase in misconduct detected by these programs. Hence, even mitigated, corporations face increased penalties as a result of their corporate policing.
Elegantly using the scoring of the Organizational Sentencing Guidelines, Arlen demonstrates that firms ought not develop compliance systems which include reporting-out if the difference between the probability of government sanction and the probability that the government detects the crime on its own is greater than 30%. There is little doubt that there is a vast disparity between the government’s ability to threaten sanctions when the evidence is presented to it on a plate and the government’s abilities to ferret out corporate wrongdoing.
Perhaps recognizing this dilemma, in 1999, then-Deputy Attorney General Eric Holder instituted a policy of deferring sanctions (Deferred or Non-Prosecution Agreements) for the implementation of government mandates, the establishment of improved internal monitoring and increased reporting of violations. This policy recognizes that compliance programs ex ante can reduce the likelihood of crime and ex post can uncover and sanction the responsible individuals.
Arlen applauds this policy but stresses that to be effective this policy requires the government to judge the quality of compliance programs. But this may be beyond the government’s abilities. We know that agency costs create incentives for managers to portray ineffective compliance programs as effective ones. And, we know that the government has failed to detect programs that are merely cosmetic. Our inability to effectively distinguish compliance programs may have led to the inefficient result that Arlen finds: Government unwillingness to reduce sanctions to levels that reward compliance programs. Rather than believing that wrongdoing has come to light because the compliance program is effective, government may be as willing to believe that reported wrongdoing demonstrates that the compliance program was toothless.
Arlen suggests that not government mandates but corporate initiatives are required for the design and implementation of effective compliance programs. At one level, compliance programs may be seen as part of a managerial or accounting task. Arlen tells us that “directors and managers of large firms need the information and oversight that a good compliance program can provide.” (n.69, P. 349.) At this level of abstraction, there is no reason to believe that lawyers have anything special to contribute to compliance programs.
When Professor Arlen focuses on compliance programs, however, she does suggest how the legal profession might battle to include corporate policing within its jurisdiction. First, implementing effective compliance programs requires skills long thought to be typical of litigators, such as investigatory skills before (P. 332) and after violations. (P. 333.) When violations are discovered, they must be reported to the authorities, with care and precision (P. 331), and then mediation and settlement activities will take place between the organization and the government. (P. 332.) An effective compliance program also requires education about the law (P. 332) and promoting the values of legal compliance. (P. 331.) Transactional lawyer skills are relevant for the design (engineering) of compliance programs. Transactional lawyers are highly attentive to conflicts of interest and these conflicts within an organization often are generators of compliance violations. (P. 331.) Transactional attorneys are well trained to spot where monitoring is required when the organization supports activities likely to generate conflicted situations. (P. 332.)
On my reading, the takeaway from this article is that government policy does and increasingly will create demand for effective corporate compliance programs and that lawyers can claim that the creation of effective programs is within their jurisdiction. That is, legal talents are incorporated in the design and implementation of any effective compliance program.
For lawyers to provide the necessary expertise to create effective compliance programs, however, requires changes in how legal work is controlled within the corporation. In brief, zealous advocates will not design compliance programs that effectively police corporations. Because litigators have sold themselves as zealous advocates, their presence in the compliance process will be met by suspicion. This is a serious challenge. But, I began this piece noting the serious times that face the legal profession. This is not the place to adequately address this challenge, but let me simply note again that engineering changed how engineers practicing within the corporation were controlled.
Ronald Gilson famously said that lawyers were transaction-cost engineers and thereby made the corporate pie grow larger. Having followed engineers inside the corporation, lawyers may find themselves becoming organizational legal engineers. Professor Arlen tells us that designing effective compliance systems will make the corporate pie grow larger. How else can organizational legal engineers make the pie grow larger?
Professor Arlen indicates that she is now reviewing deferred prosecution agreements to uncover the variety of government mandates and compliance programs that they include. Her research undoubtedly will uncover other skills necessary for the design and implementation of effective corporate policing. Given the needs of law students, let’s hope some of these skills are lawyerly ones. And that without their work, we can only expect The Failure of Organizational Sentencing Guidelines.
Jan 27, 2012 Sharon Gilad
The seminal socio-legal work of Neil Gunningham, Robert Kagan and Dorothy Thornton suggests that social activism is an important influence over firms’ inclination to comply with – and even exceed – regulatory environmental-protection requirements. They further acknowledge that corporations vary in their responsiveness to similar levels of societal pressure, and that the micro-mechanisms underlying this variation require further investigation. Similarly, a recent body of research in sociology and management investigates corporations’ responses to social protest. Yet, much of this literature investigates firms’ average or overall response to social protest, and not the variation among firms. The significance of Weber et al.’s article – From Street to Suits: How the Anti-Biotech Movement Affected German Pharmaceutical Companies – stems from its focus on micro-level analysis of firms’ varied response to social protest.
Weber et al.’s research investigates “how external contestation manifests itself in the internal polity of organizations” (ibid, 109). Their empirical focus is on German pharmaceutical companies’ decisions to invest in the development of biotechnology given an anti-genetic social-movement activism during the 1980s. In order to answer this question, the authors collected press coverage, various primary documents, interviews and secondary sources and produced in-depth portrayal of the social movement and of the responses of six leading German pharmaceutical companies.
Their overall findings and thesis is that the impact of social movement activism on firms’ commercial decisions is a function of the campaign intensity and its mediation by intra-corporate factors and processes. Thus, as a general rule, those firms that were targeted by successful activist mobilization – usually larger firms – were more likely to withdraw from (or to lower their pace of progression in) biogenetic projects. Yet, this overall impact was mediated by intra-organizational conflicts and identity as follows. First, the societal contestation of biotechnology rendered internal champions of the technology less decisive in their fight for their firms’ investment in new research and development due to their concern about damaging their corporate and individual reputations vis-à-vis external audiences.
Conversely, the risk that biotechnology created for firms’ reputations became a sword in the hands of executives and scientists who advocated investing in more traditional –non-biotechnology – pharmaceutical projects. In more diversified firms, which produced not only chemicals but also consumer healthcare products, those advocating investment in biotechnology projects faced particularly high competition from elites with alternative investment agendas.
Second, the social contestation of biotechnology generated uncertainty about its future regulation, and consequently reduced its projected value in comparison with alternative projects.
Third and related to the above, the internal competition within firms and the relative weight given to regulatory uncertainty was further shaped by firms’ organizational identities. Firms which viewed themselves as “core pharmaceutical producers” were more inclined to perceive biotechnology as an inevitable scientific trend, and therefore to give lower weight to societal protest and to regulatory uncertainty in their investment decisions. By comparison, firms which conceptualized themselves as a “diversified business portfolio” were more inclined to forgo investment in biotechnology in favor of alternative projects with more secure financial returns. As a result, large and diversified firms were more likely to withdraw from the biotechnology market or to move too slowly, whereas smaller firms with a core pharmaceutical identity were more inclined to successfully launch new products.
Fourth, the authors illustrate the path dependent impact of firms’ response to social protests. Rather than withdraw from the biotechnology market, some firms chose to shift their production outside Germany or to states (Landers) with less vigorous social opposition and away from their headquarters. As a result, biotechnology teams were physically distanced from the corporate centre, resulting in project coordination problems and in their weaker political position within the firm.
So what is noteworthy about the above findings and conclusions? First, their significance lies in depicting the impact of societal pressure on firms not in terms of gradual normative internalization, as typically suggested by socio-legal scholars, but as a factor that penetrates firms’ commercial investment decisions. Second, they are important in highlighting corporations’ investment decision making as a political process, wherein external societal signals are framed in light of internal struggles over alternative projects. This portrayal diverges from a common tendency to depict corporations as coherent unitary actors. Third, the article shows how corporations’ varied identities mediate their relative openness to external pressures.
