The Market for Corporate Criminals
Andrew K. Jennings
This Article identifies problems and opportunities at the intersection of mergers and acquisitions (M&A) and corporate crime and compliance. In M&A, criminal successor liability is of particular importance, because it is quantitatively less predictable and qualitatively more threatening to buyers than successor liability in tort or contract. Private successor liability requires a buyer to bear bounded economic costs, which can in turn be reallocated to sellers via the contracting process. Criminal successor liability, however, threatens a buyer with non-indemnifiable and potentially ruinous punishment for another firm’s wrongful acts.
This threat may inhibit the marketability of businesses that have criminal exposure, creating social cost in the form of inefficient allocations of corporate control. Such a result would be unfortunate because M&A could instead be a lever for promoting compliance. Yet criminal successor liability undermines this possibility and, in turn, the public’s interest in compliance. To countervail these problems, this Article proposes new prosecutorial policies that, through better targeted sanctions and compliance-enhancing mergers, would promote M&A markets, deter corporate crime, and foster corporate reform.
This Article tackles problems at the intersection of two seminal papers, George Akerlof’s The Market for “Lemons” and Henry Manne’s Mergers and the Market for Corporate Control. The problems arise from the acquisition by M&A buyers of not just target firms’ private assets and liabilities but also their criminal or regulatory (i.e., quasi-criminal) offenses. That is, if A commits a criminal offense, and if B then acquires A, B is liable for A’s offense despite being uninvolved in its commission. In the case of private-law (i.e., tort or contract) claims, successor liability can be justified as preventing firms from evading private obligations through restructuring. In arm’s-length M&A transactions, buyers can manage private successor liability through contractual terms that reallocate those costs and risks onto sellers. In the case of successor liability for criminal offenses, however, the serious non-financial consequences of criminal conviction cannot be neatly managed through contractual risk allocation. Instead, distinctive consequences of criminal liability could, at the margin, frighten potential buyers away from otherwise-attractive deals. The result would be a suboptimal level of M&A activity: firms that would be ideal targets for acquisition but for their potential criminal exposure might sell for suboptimal prices or to suboptimal buyers, or they might not sell at all. This problem represents a social cost in that one of corporate law’s key mechanisms for addressing business deficiencies — the market for corporate control — might fail when the deficiency in question is a culture of lawbreaking.
The acquisition of Bankrate — a once-public financial firm — by Red Ventures — a private marketing company — is an instructive example. In 2012, the U.S. Securities and Exchange Commission (SEC) raised concerns with Bankrate about its financial reporting, leading to the discovery that its CFO had regularly engaged in a form of securities fraud known as a cookie-jar accounting. In 2017, Red Ventures, although it was aware of the accounting issues, bought Bankrate for approximately $1.4 billion. The investigation continued and later that year Red Ventures and the U.S. Department of Justice (DOJ) entered into a non-prosecution agreement (NPA). Under the NPA, DOJ acknowledged that “Red Ventures acquired Bankrate, Inc. after the criminal conduct had taken place and had been investigated by the government, and Red Ventures had no involvement in any of the misconduct . . . .” By that point, Bankrate was no longer an independent concern and its former directors, executives, and shareholders were long gone. Nevertheless, Red Ventures “admit[ted], accept[ed], and acknowledge[d] that it [wa]s responsible under United States law for the acts of [Bankrate’s former] officers, directors, employees, and agents” in connection with the old CFO’s fraud.
By the time Red Ventures signed the NPA, Bankrate’s former CFO was a year into a ten-year fraud sentence and had not worked at the company for over four years. Nevertheless, Red Ventures was obliged to pay $15 million, plus interest, in disgorgement and another $13 million in restitution to former Bankrate shareholders harmed by the fraud. These payments were just: victims were compensated and Red Ventures was not allowed to keep its predecessor’s ill-gotten gains. In one light, this criminal resolution had a similar effect to successor liability for private claims: those with tort or contract claims against a predecessor may seek compensation from its successor. Yet, beyond those compensatory provisions, the NPA also required Red Ventures to pay an additional $15.54 million penalty. That is, Red Ventures was punished for misconduct that DOJ acknowledged it had nothing to do with. These amounts were in addition to the company’s legal fees and other costs of cooperating with the government’s investigation. The NPA also imposed future costs in the form of cooperation and compliance undertakings, which were meant to ensure that Red Ventures would not engage in further misconduct notwithstanding that it did not own Bankrate at the time of the fraud. The disclosed restitution, disgorgement, and penalties represented about 3% of Bankrate’s $1.4 billion purchase price. Other costs, like legal fees, are not publicly available but were likely significant: similar matters have cost companies tens of millions of dollars.
All this, despite the government’s acknowledgment that Red Ventures hadn’t engaged in the prior misconduct: Bankrate, the company it acquired, had. Yet the Bankrate case demonstrates that what would be remarkable in the individual context — that one person assumes criminal liability for another — is unremarkable in the corporate context. This effect follows from two doctrines. First, a firm is vicariously liable for crimes committed by employees and agents within the scope of their employment, so long as they had some intent to benefit the firm, however slight the intent or the benefit. Second, an acquirer bears successor liability for wrongdoing of a predecessor firm, even if all misconduct stopped before the succession. Successor liability makes a buyer responsible for torts or contractual breaches committed by its predecessor. Indeed, the restitution Red Ventures paid under the NPA to Bankrate shareholders had a compensatory effect akin to successful private securities litigation. But successor liability also makes an acquirer responsible for criminal offenses committed by its predecessor. Beyond the economic transfer effected by its NPA with DOJ, Red Ventures was made to bear penalties and other sanctions as if it itself should be blamed for Bankrate’s past securities fraud.
This motivating example evokes fundamental questions of corporate criminality: why should a firm, which can “act” only through human beings, be said to be a “criminal,” form criminal intent, or be blamed for criminal acts? And doesn’t the idea of acquired crimes mock the legal fiction of corporate crime all the more? These questions are left open here. Instead, given the reality of corporate criminal liability, I theorize the problems it creates for M&A and corporate compliance. These problems appear in three sometimes-overlapping scenarios: a buyer learns of unsettled criminal liability after closing; it learns of unsettled criminal liability before closing; or the target’s criminal liability has been settled but is subject to ongoing probationary obligations at the time of closing. Together, these scenarios raise a subset of M&A practice I call “criminal M&A.” The criminal-M&A problem I focus on is not so much the potential for normatively unjust punishment of buyers for sellers’ misdeeds. Rather, it is that vicarious and successor liability, in concert with enforcement agencies’ exercise of prosecutorial discretion, can inhibit the market for corporate criminals. That is because acquirers will rationally wish to avoid the substantial economic, stigmatic, opportunity, and collateral costs of acquired criminal liability.
The inhibition of criminal M&A imposes social cost to the extent that M&A is thought to increase economic efficiency, promote entrepreneurship and innovation, and reduce agency costs. These benefits are lost if, at the margin, fear of successor criminal liability prevents, or leads to inefficient, deals. Instead, criminal M&A could be promoted as a means by which buyers reform inadequate compliance levels in targets. This reformative potential finds analogs in other contexts: a typical M&A buyer might correct ineffective sales practices, underinvestment, managerial agency costs, and so on, thereby putting acquired assets to higher-value use. Criminal M&A’s reformative potential means that it could promote the public’s interest in corporate compliance: one way for a criminal firm to become law abiding is to be acquired by a law-abiding buyer with the ability and wherewithal to reform it. A mirror social concern is that criminal M&A could lead to undesirable selection effects in which low-compliance firms obtain misconduct synergies by acquiring other low-compliance firms. Such deals could run counter to public interest because the combined concern would continue to break the law, but at greater scale.
Criminal M&A can also make possible the imposition of tougher penalties than would be feasible in other enforcement contexts. Prosecutors are reluctant to impose high, but perhaps penologically appropriate, penalties on going concerns due to the social cost of doing so. As an example of this prosecutor’s dilemma, imagine a hospital that has defrauded insurers through tens of millions in false billings. A hefty penalty might be appropriate for that kind of wrongdoing. But if such a penalty would financially destabilize the hospital or reduce its ability to care for patients and provide employment in its service region, prosecutors would discount an otherwise-appropriate penalty to a level that would not risk reductions in patient care or local employment. The social and political costs would be too high to do otherwise.
Yet when an offender firm is sold, for a brief moment, its value is fully liquid, allowing those thirdparty costs to be avoided. If there is an acceptable offer on the table, then some part of the consideration could be used to cover the target’s criminal liabilities or even to fund the buyer’s remediation efforts. Prosecutors could further offer the buyer amnesty from criminal successor liability — or spare it punitive sanctions, at least — for any pre-closing liability for which the target is liable. In cases when there is no imminent M&A deal, prosecutors could impose a full penalty but make its payment contingent on being paid from the purchase price of any future acquisition. This approach would in effect allocate the costs of corporate crime to current shareholders, in turn de-risking criminal M&A for future acquirers. As a result, there would be stronger ex-ante deterrence due to the greater incentive for shareholders to monitor compliance. That is, if M&A gives prosecutors methods to isolate the full costs of corporate crime to shareholders, then they would have no need to discount sanctions to protect third-party stakeholders. And if, as a result, shareholders expect to bear the undiscounted cost of corporate wrongdoing, they will be more likely to use levers of shareholder power to ensure that management maintains an effective, as opposed to cosmetic, compliance program. This move would create a new compliance environment in which preventing corporate wrongdoing would be imperative to shareholders because they would bear its costs otherwise.
This Article addresses the questions raised by criminal M&A in three parts. Part I frames criminal M&A as an interaction of information asymmetries, adverse selection, agency- and corporate-law doctrine, and prosecutorial policy. It analyzes the effects of these causes on three M&A submarkets: the markets for unknown corporate criminals, for known corporate criminals, and for corporate probationers. Part II shows that three persistent problems of corporate crime and compliance—ex-post enforcement, ex-ante compliance, and post-enforcement reform— find partial causes and solutions in the market for corporate criminals. Part III recommends reforms to prosecutorial practice that would serve to disinhibit criminal M&A. It further explains how a healthy market for corporate criminals can promote ex-ante compliance (i.e., deterring corporate offenses), ex-post enforcement (i.e., appropriately sanctioning corporate offenses), and post-enforcement reform (i.e., preventing corporate recidivism).
These Parts lead to several principal conclusions. First, criminal liability is a special problem in M&A in that compared to private successor liability, it tends to be quantitatively less predictable and qualitatively more threatening to prospective buyers. Second, the doctrines of vicarious and successor liability, which drive the problem of successor criminal liability, can undermine M&A markets. And last, these problems can be addressed through prosecutorial policies that promote a socially beneficial market for corporate criminals.
— from The Market for Corporate Criminals, 40 Yale Journal on Regulation 520 (2023)