Corporate Compliance Prof Blog

Ellerth/Faragher Update No. 1

Here is the first batch of Ellerth/Faragher updates, and it covers the period from September 2004 through April 2005.  I do not catalogue every case to address the defense, instead noting only those cases that shed light on what makes an employer's compliance program effective. Consequently, I omit cases either that reach a summary conclusion without helpful analysis,  or that deny the affirmative defense because the employee had properly pursued the employer's compliance processes.  Also, while I note unpublished opinions from the courts of appeals, I report only published opinions from the district courts.

(These summaries are taken from a discussion I wrote as co-reporter for the Corporate Compliance Survey of the Corporate Compliance Committee of the ABA’s Business Law Section.  The Survey is to be publsihed in the August 2005 issue of The Business Lawyer.  My co-reporter for the Survey was Jean K. FitzSimon, co-Chair of the Corporate Compliance Committee, and Senior Vice President and General Counsel of Whitehall Jewellers.)

Harmon v. Home Depot USA Inc., 130 Fed. Appx. 902, 904 (9th Cir. 2005).  Upholding summary judgment for an employer that "had a written sexual harassment policy. The policy had several means for reporting harassment including a toll-free number employees could call anonymously. Employees were trained on the policy when they started work. Employees signed a form stating they were trained and understood [employer's] non-harassment policy."

Olson v. Lowe's Home Centers Inc., 130 Fed. Appx. 380, 389 (11th Cir. 2005).  The employer took reasonable care to prevent harassment "by promulgating and effectively disseminating several fairly extensive anti-harassment policies to employees [that] enabled employees to bypass harassing supervisors and provided several different avenues for employees to report sexual harassment." The employer, however, was not entitled to summary judgment on its affirmative defense because a fact issue existed on whether the employee unreasonably failed to pursue employer's processes.

Clark v. United Parcel Service, Inc., 400 F.3d 341, 349-50 (6th Cir. 2005).  The employer's sexual harassment policy was sufficient because it at least "(1) require[d] supervisors to report incidents of sexual harassment; (2) permit[ted] both informal and formal complaints of harassment to be made; (3) provide[d] a mechanism for bypassing a harassing supervisor when making a complaint; and (4) and provide[d] for training regarding the policy." The employer, however, was not entitled to summary judgment on its affirmative defense because of fact issues regarding the reasonableness of its response to the harassment report.

Loughman v. Malnati Organization Inc., 395 F.3d 404, 407 (7th Cir. 2005).  Overturning summary judgment for the employer on the Ellerth/Faragher affirmative defense because first, simply securing the harasser's verbal assurance of no further harassment might be inadequate response to physical harassment, and second, "consistent stream of harassment . . . suggests that [employer's] policy was actually not very effective at all."

Hesse v. Avis Rent A Car System, Inc., 394 F.3d 624, 630-31 (8th Cir. 2005).  Evidence of the employer's corrective actions warranted summary judgment for employer on affirmative defense.

Petrosino v. Bell Atlantic, 385 F.3d 210, 226 (2d Cir. 2004).  While the employer had a sexual harassment policy and a reporting hotline, the employee raised a fact question about effectiveness of these measures by offering evidence that hotline operator refused her request to speak with a female counselor and then failed to investigate her claim.

Presley v. Pepperidge Farm, Inc., 356 F. Supp. 2d 109, 128 (D. Conn. 2005).  The employer had an adequate harassment policy because it had "posted written copies of the policy in multiple locations in the plant where [the alleged victim] worked[; the employer] informed newly hired employees of the policy during their orientation[; and] human resource officials walked around the floor of the plant to make themselves more accessible to employees." This was so even though "there were multiple versions of the policy in circulation at the time of" the alleged harassment because "all versions of the policy before the court prohibit any kind of sexual harassment, instruct employees to whom they can complain, assure that the company will take prompt and appropriate action, promise confidentiality, and ensure that employees will not be penalized or retaliated against for filing a complaint." However, a genuine issue of material fact existed as to whether the policy was adequately enforced.

Miller v. Edward Jones & Co., 355 F. Supp. 2d 629, 639 (D. Conn. 2005).  Even though the employer adequately investigated the harassment complaint, a fact issue prevented summary judgment on the Ellerth/Faragher defense because the employee claimed that "the company offered her no alternative other than to return to work in a two-person office alone with the man (her supervisor) who was continually harassing her."

Jones v. District of Columbia, 346 F. Supp. 2d 25, 48-49 (D. D.C. 2004).  The employer satisfied the first element of the Ellerth/Faragher defense because it "did have a written anti-harassment policy with complaint procedure, a copy of which was provided to [the alleged victim] during her training-before she began working at [the employer's workplace]. [The employer] took immediate corrective action upon receipt of [the] harassment complaint, issuing cease and desist letters to prevent further contact between [the alleged harasser and victim], and beginning an investigation into [the] allegations."

Talamantes v. Berkeley County School Dist., 340 F. Supp. 2d 684, 697 (D. S.C. 2004). A school district was found to have a reasonable sexual harassment policy because it: "adopted policies that prohibit sexual harassment and provided a complaint procedure that permits an alleged victim of harassment by a supervisor to bypass the supervisor with a complaint or grievance"; "[t]he policy expressly prohibits the type of conduct [the employee] alleges: physical conduct of a sexual nature, offensive comments or slurs, and visual harassment"; "[t]he policy also requires administrators to initiate a prompt investigation once they receive a complaint"; "the policy is distributed to . . . employees during their initial employment and annual orientation"; "supervisory employees, including custodial supervisors, receive sexual harassment training on an annual basis through memos and formal presentations"; and "[t]he policies themselves are available in the principal's office in every school in the District . . . as well as on the District's Internet website." Also, the court rejected the employee's claim that she was unaware of the employer's policy because the employee submitted a sexual harassment complaint in the form and manner prescribed by the policy.

Boyd v. Snow, 335 F. Supp. 2d 28, 36 (D. D.C. 2004).  A fact issue prevented summary judgment on the Ellerth/Faragher defense because of evidence that, among other things, the employer "did not offer to remove [the alleged victim] from the allegedly abusive environment."

Oleyar v. County of Durham, 336 F. Supp. 2d 512, 519 (M.D. N.C. 2004).  The employer "exercised reasonable care to prevent and promptly correct harassing behavior through an anti-discrimination policy of which [alleged victim] was apprized [sic]."

Compliance 101 -- The Ellerth/Faragher Defense

In a prior post I noted that an effective compliance and ethics program can prevent vicarious liability for supervisor sexual harassment under federal employment discrimination law.  In the coming week or so, I will devote several posts to updates on sexual harassment cases decided over the last few months, focusing on what these cases say about good and bad compliance practices.  As background for the coming posts, this post offers a brief description of the legal background.

In its 1998 decisions in Burlington Indus., Inc. v. Ellerth  and Faragher v. City of Boca Raton,  the United States Supreme Court held that employers were vicariously liable under federal employment discrimination law  for sexual harassment committed by their supervisory employees.  If the sexual harassment did not result in a tangible employment action, such as firing, demotion, or reduction of pay,  the employer can avoid vicarious liability by pleading and proving a two-element affirmative defense: "(a) that the employer exercised reasonable care to prevent and correct promptly any sexually harassing behavior, and (b) that the plaintiff employee unreasonably failed to take advantage of any preventive or corrective opportunities provided by the employer or to avoid harm otherwise."  Note that "reasonable care to prevent and correct promptly" the harassment-basically, a compliance program-is a necessary but not sufficient condition of the affirmative defense. Even if the employer has a state-of-the-art sexual harassment compliance program, the affirmative defense fails if the victim abided by the organization's program. Ironically, then, vicarious liability attaches despite the compliance program working precisely as intended.

The Court offered two elaborations on the affirmative defense, both of which have guided lower courts. First, "[w]hile proof that an employer had promulgated an anti-harassment policy with complaint procedure is not necessary in every instance as a matter of law, the need for a stated policy suitable to the employment circumstances may appropriately be addressed in any case when litigating the first element of the defense."  As noted above, drafting written compliance policies is one of the basic compliance tasks under the Sentencing Guidelines, so it is not surprising that the Court would expect a reasonable sexual harassment compliance program to have one. The lower courts have followed this logic,  denying the affirmative defense to employers that either had no written policy,  had a written employment discrimination policy that did not specifically address the type of harassment involved,  or did not consistently distribute or train employees on the sexual harassment policy.

Second, the cautious employer should also have a sexual harassment complaint procedure because an employee's unreasonable failure to use the procedure will "normally suffice to satisfy the employer's burden under the second element of the defense."  This is another area where lower courts have heeded the Court's dicta. For example, several courts have highlighted the need for employers to have a compliant procedure that allows employees to bypass an allegedly harassing supervisor.

Compliance and Electronic Storage of Client Confidences

ABA Model Rule of Professional Conduct 5.1(a) requires supervisory lawyers to ensure that their
firms or legal departments implement legal ethics compliance measures:

(a) A partner in a law firm, and a lawyer who individually or together with other lawyers possesses comparable managerial authority in a law firm, shall make reasonable efforts to ensure that the firm has in effect measures giving reasonable assurance that all lawyers in the firm conform to the Rules of Professional Conduct.

This requirement falls on individual lawyers and cannot be sloughed off on the firm or legal
department.  (New York and New Jersey allow discipline of law firms.)  Arizona Ethics Opinion
05-04 applies that state's version of Model Rule 5.1(a) (as well as other applicable rules) to a lawyer’s duty to protect client confidences.  A lawyer sought guidance on the following situation:    

The Inquiring Attorney has sought guidance from the Committee regarding the steps the lawyer’s firm must take to safeguard electronic client information from Internet hacking and viruses. The Inquiring Attorney’s firm has, until recently, kept documents which include confidential client information in electronic form on a computer system which is accessible only from computers within the law firm itself. Although the law firm had access to the internet, that access was through a separate computer system. Neither the computer system on which the client information was stored nor any computer which could access that information was ever connected to the internet.

The Inquiring Attorney’s firm now wishes to change that system and allow attorneys and staff to access the internet through the same computers they use to access the client information. Though the Inquiring Attorney does not specifically state this, it is assumed that firm attorneys and other employees will be able to access the client documents remotely. That is, an attorney or other employee may access this information from a computer outside the physical offices of the firm. Such access would be through the internet.

QUESTION PRESENTED

How do we protect the confidentiality and integrity of client information while continuing to increase reliance on internet for research, filings, communication, and storage of documents?

The reality of modern communication and data storage is that electronic information is vulnerable
to attack, unauthorized access, and destruction, and that many lawyers do not have the
technological knowledge to address those threats.  Nonetheless, the Arizona Bar interpreted its
rules to require its lawyers to adequate precautions and suggested how lawyers might do so:

. . . .  A panoply of electronic and other measures are available to assist an attorney in maintaining client confidences. “Firewalls” – electronic devices and programs which prevent unauthorized entry into a computer system from outside that system – are readily available. Recent upgrades in Microsoft operating systems incorporate such software systems automatically. A host of companies, including Microsoft, Symantec, McAfee and many others, provide security software that helps prevent both destructive intrusions (such as viruses and “worms”) and the more malicious intrusions which allow outsiders access to computer files (sometimes call “adware” or “spyware”).

Software systems are also readily available to protect individual electronic files. Passwords can be added to files which prevent viewing of such files unless a password is first known and entered. The files themselves can also be encrypted so that, even if the password protection is compromised, the file cannot be read without knowing the encryption key – something that is extremely difficult to break.

Precisely which of these software and hardware systems should be chosen – and the extent to which they must be employed – is beyond the scope and competence of the Committee. This is the kind of thing each attorney must assess. The expectation of the client that the client’s records and communications will be held in confidence is significant.

As set forth in the Comment to ER 1.6, an attorney must not only take reasonable precautions to protect client confidences, the lawyer must “act competently” in that regard. ER 1.1 requires, in general terms, that a lawyer act competently with regard to client representation. ER 5.1 and 5.3 require that a lawyer manage the lawyer’s firm and assistants in such a way as to be certain that the lawyer’s ethical responsibilities are discharged. Once again, it is the lawyer’s individual responsibility to know when the lawyer can act competently or not.

And the Opinion goes on to address lawyers who might profess technological ignorance:

It is not surprising that few lawyers have the training or experience required to act competently with regard to computer security. Such competence is, however, readily available. Much information can be obtained through the internet by an attorney with sufficient time and energy to research and understand these systems. Alternatively, experts are readily available to assist an attorney in setting up the firm’s computer systems to protect against theft of information and inadvertent disclosure of client confidences.

I find it interesting that the Opinion makes no mention of similar data protection requirements in other industries.  This is especially odd given that lawyers routinely advise their clients on compliance with such data retention requirements.  Why not put that same advice to work in one's own firm.  And for lawyers without familiarity with such regulations, the Opinion could have given further, concrete guidance by pointing the practicing bar to the vast compliance literature that discusses how to design, implement, and test such compliance measures.

FCPA -- The Bribe/Accounting Trap

The White Collar Crime Prof Blog had a recent post on the Foreign Corrupt Practices Act (FCPA) that reminds me of an important point to remember about that statute.  For the uninitiated, the FCPA has two parts: the accounting provision and the anti-bribery provisions.  The post at White Collar Crime Prof Blog discussed a violation of the FCPA’s accounting provision.  In this post, I raise an often ignored link between the accounting and anti-bribery provisions of the FCPA.  (Also, this is one of my favorite compliance statutes, so expect to a lot more on this compliance risk in the future.)

The accounting provision basically requires that all public companies keep accurate financial records and maintain internal controls adequate to produce such records.  For the text-minded, here is the relevant portion of the statute:

(2) Every issuer which has a class of securities registered pursuant to section 78l of this title and every issuer which is required to file reports pursuant to section 78o(d) of this title shall--

(A) make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer; and

(B) devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that--

(i) transactions are executed in accordance with management's general or specific authorization;

(ii) transactions are recorded as necessary (I) to permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and (II) to maintain accountability for assets;

(iii) access to assets is permitted only in accordance with management's general or specific authorization; and

(iv) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences.

Note that the accurate records requirement has no materiality threshold and no de minimis exception.  A person commits a crime if they “knowingly circumvent or knowingly fail to implement a system of internal accounting controls or knowingly falsify any book, record, or account described in paragraph (2),” regardless of the size of the transaction falsely recorded.

The ant-bribery provision is more akin to your typical criminal statute.  Loosely stated, an anti-bribery violation has the following elements:

(1)    A person covered by the statute

(2)    uses interstate or foreign commerce

(3)    to make an offer or payment of anything of value

(4)    to a foreign official

(5)    with a corrupt purpose

(6)    and to obtain or retain business.

Of course, there will be some gray areas as to what counts as something of value paid with corrupt intent to a foreign government official.  For example, what if a company pays for honeymoon airline tickets for the cousin of a government official who will participate in the decision whether to award business to the company?  While one court of appeals held that this was a prohibited bribe under the FCPA, the case had to be litigated for a long period of time to reach that conclusion.

But, some companies may box themselves into a corner under the FCPA’s accounting provision so that they cannot realistically litigate any anti-bribery issue.  Consider a company that makes a contribution to a foreign charity, and the charity is chaired by a foreign official who will participate in the decision whether to award business to the company.  The SEC brought a civil enforcement action against a company on similar facts.  At first, you might think that the company had a strong counter-argument – no money was paid directly to the government official, and the intent of the contribution was charitable and not “corrupt.”  One other fact, however, made the case a slam dunk for the government – the company knowingly recorded the payments on its books as something other than charitable contributions, which is a clear violation of the FCPA’s accounting provisions.  Given that the accounting violation was straightforward, the company settled the matter.  This teaches an important lesson: Even payments that are arguably allowed under the FCPA’s anti-bribery provisions will illegal under the counting provisions if the company knowingly misstates the payment on its books.  So, even if a company decides certain payments are legal, MAKE SURE that they are properly recorded.

Export Control Compliance

Here is a cite to a great recent article on a very hot topic -- compliance with United States export
control laws:

Tara L. Dunn, Surviving United States Export Controls Post 9/11: A Model Compliance Program, 33 Denver Journal of International Law and Policy 435 (2005).

The author is a recent graduate of the University of Denver Sturm College of Law.  The beauty of
the article is that it collects a variety of compliance forms and checklists tailored to United States
export control laws.  Very useful.  Unfortunately, the article does not appear to be available
electronically for free – the excerpt posted below is from a pay online service.  So, you may have
to trudge to a brick and mortar library to find the book.

Here is a wonderful description of the article’s content and approach, which appears in a special
introduction to the article written by Mark Menefee, who is of counsel at Baker & McKenzie LLP
and the former director of the Office of Export Enforcement, Bureau of Industry and Security in
the United States Department of Commerce:

When a law enforcement officer looks at a company, one of the first questions he or she asks him or herself will be: "Are these people good guys or bad guys?" Much is at stake for the officer. Initial information about the company's activities helps the officer decide not only how to begin the inquiry but, more importantly, how best to protect the safety of the officer and his or her fellow officers when dealing with the company. An investigator approaching an unknown office building is taking a personal safety risk no less than a police officer approaching a car that has been pulled over on the highway. While an officer investigating a so-called "white collar crime" will be typically less likely to encounter a violent response from the person under investigation than, say, an officer investigating a drug smuggling operation, the training for federal criminal investigators emphasizes the possibly fatal consequences to the officer from making incorrect assumptions about the level of threat posed by a person who is the subject of the officer's initial questions.

If you were a federal agent charged with responsibility for investigating white collar crimes such as export control violations or securities fraud, and felt keenly the need to make a quick and accurate first assessment of whether a company consists of good guys who may have made a technical mistake, or terrorist supporters who wouldn't hesitate to defraud other companies in order to accomplish their mission, and who are completely willing to kill you in the process, what would be your test? On an interpersonal level, your initial "gut reaction" about the truthfulness of the people you meet and interview will tell you a great deal--but only about those individuals, not necessarily about the corporation as a whole. Is there some other information, at the corporate level, that could help you quickly assess the character of the whole organization?

At the initial stage of an investigation the single best indicator of whether a company is law abiding is whether the company has an effective compliance program. "According to available information, only 2 of the 865 corporations sentenced for federal crimes during the last eight years had effective compliance programs. Of the 143 organizations sentenced under Chapter 8 in 2002, not one maintained any type of compliance program whatsoever." These sentencing statistics must be understood properly. It does not follow from these statistics that a company can avoid possible criminal liability by merely officially adopting a compliance program. What does
follow is that there is a strong correlation between crimes committed by corporations and a complete disregard of their compliance responsibilities by the management of those corporations.

In other words, companies whose managers choose not to take their compliance responsibilities seriously are flying blind. They are significantly more likely to commit violations of complex regulatory regimes, such as those governing exports, than companies that maintain reasonably effective compliance programs. They also are much more likely to generate the sort of "smoking gun" memos and email that reveal full well their negligence or their knowing and willing intent to violate laws impeding their short term business plans. An experienced federal investigator knows that when he or she finds a company operating without an effective compliance program, the odds are in favor of discovering evidence of a crime.

The vast majority of business people have absolutely no desire to commit regulatory crimes. But small- and medium-sized companies must make difficult choices about how to come up with the money needed to insure a reasonable degree of compliance. Start-up companies find regulatory compliance to be especially difficult to fund. In the area of export controls, where the regulations are quite complex, the costs of running an effective compliance program can be very high. However, because export controls safeguard the national security of the United States and itsallies, the penalties for violations can be devastating. It is not uncommon for violators to be subject to criminal and civil fines as well as denials of export privileges; often penalties will be
imposed not only against the corporation but against the midlevel managers or senior executives as well. Small- and medium-sized firms, and their owners, are especially susceptible to multiple penalties.

Tara Dunn's model compliance program provides a great service to the international business community. Her program can help a smaller company, or a new start-up firm, reduce its initial export compliance costs while achieving a sophisticated level of compliance. If a company will take to heart the importance of complying with U.S. export controls and use Ms. Dunn's model program as its standard, it will be able to manage its risks effectively and economically.  Moreover, not only will the company detect potentially illegal transactions and avoid being pulled into diversion schemes, it also could use the compliance program as a form of strategic planning for potential overseas markets. Ms. Dunn's model program might strike a reader who is unfamiliar
with the nuances of export controls as being overly elaborate and complex, with too much technical terminology. It is not. In fact, the very careful and detailed legal analysis underlying her program needs to be understood by the management of a company when they consider implementing their own compliance program. Managers will need to take the model program and adapt it to fit their company's particular markets, product lines, and business processes. Then they will be able to simplify parts of the model program to fit the level of training and understanding of the employees who will actually implement the program. This is as it should be. What is important
is that they begin with a model program that actually gets the law right, and that provides the specific legal basis for particular components. This model compliance program does just that.

This excerpt might be good to copy and hand out to a company’s board of directors – there are
several observations that are important to remember.  First, I particularly like the observation that
a regulator approaching an unknown company does so knowing only that they see smoke (which
is what attracted the regulator’s attention), and that (usually) where there’s smoke, there’s fire.
Plus, you might add that post-Enron, regulators a bit skittish, as no one wants to be the person
who (through the clarity of 20-20 hindsight) missed the early warning signs of the next big
scandal.  So, being human, regulators are naturally (perhaps necessarily) skeptical when they
arrive a company’s doorstep.

Second, Mr. Menefee gives perhaps one of the best endorsements possible for a compliance
program.  When the skeptical regulator arrives, they may have the following in mind:  “At the
initial stage of an investigation the single best indicator of whether a company is law abiding is
whether the company has an effective compliance program.”  And this initial impression may
become the lens through which the government sees all the facts that follow.  When a fact equally
implies suspicious or benign conduct, the government’s assessment of the organization’s character
will drive which inference is ultimately drawn.

Lower Incidence of Tort Cases in Federal Court

Well, it looks like tort reform is working, or Americans have become less litigious, at least in the federal courts.  The August 2005 Bureau of Justice Statistics Bulletin reports the following findings from the Federal Justice Statistics Program:

From 1985 to 2003 the number of tort trials terminated in U.S. district courts declined 79%. Juries decided about 71% of tort trials in 2002-03, while judges adjudicated the remainder.  Plaintiffs won in almost half of tort trials, and the estimated median award garnered by plaintiff winners in these trials was $201,000. Personal injury claims comprised almost 90% of tort trials in U.S. district courts and property damage cases accounted for the remaining 10%. Almost two-thirds of tort trials were disposed of within 2 years of the filing date.

These are some of the findings from a report presenting data on tort cases decided by a jury or bench trial in U.S. district courts during fiscal years 2002 and 2003. Data for this 2-year period were combined to provide a larger number of cases for detailed analysis.  Previously, the Bureau of Justice Statistics (BJS) reported findings from a study of tort trials terminated in U.S. district courts during fiscal years 1994-95 and 1996-97.  This report focuses primarily on tort cases terminated by trial in U.S. district courts during fiscal years 2002-03 as well as trends in tort cases terminated in U.S. district courts since 1970.

Analysis is limited to those cases terminated after the completion of a trial by jury or a trial before a district judge or magistrate judge. According to the Administrative Office of the U.S. Courts (AOUSC), a trial is considered complete when a verdict is returned by a jury or a decision is rendered by the court.  Jury or bench trials terminated before verdict or judgment were excluded from this analysis. Tort cases that were settled, dismissed, or disposed through summary judgment in the Federal district courts were not reported.

Of course, given the amount in controversy, diversity, and federal question requirements for federal subject matter jurisdiction, most tort cases are filed in state, not federal, courts.  Indeed, the Bulletin notes:

The National Center for State Courts (NCSC) reports that in 2002 16.3 million civil cases were filed in State courts of general (7.7 million) and limited (8.6 million) jurisdiction. In comparison, 274,841 civil cases were filed in Federal district courts during fiscal year 2002. NCSC, Examining the Work of State Courts, 2003: A National Perspective from the Court Statistics Project, Williamsburg, VA, and AOUSC, 2002 Annual Report of the Director: Judicial Business of the U.S. Courts, Washington, D.C.

I'm not quite sure what to make of this from a compliance perspective.  On the one hand, the data indicates lower tort risk, which should affect where one prioritizes tort liability in the risk assessment.  On the other hand, this is just federal courts, and (as noted above) most tort suits are filed in state court.  Further, it says little about the incidence of tort suits in specific industries, focusing on braod categories such as product liability and medical malpractice.  Also, we do not know whether the decline in federal tort suits is due to changes in tort law, federal jurisdiction, improvements in product/service safety, or some other factor.  Probably not enough in this report to affect or inform an organization's risk assessment.

California Supreme Court Sexual Harassment Decision

Miller v. Department of Corrections, a decision handed down yesterday by the California Supreme Court, holds that the state’s employment discrimination statute supports a sexual harassment claim for supervisor’s affair with a subordinate by a plaintiff who was not involved in the affair.  The introduction to the Court’s opinion explains the decision:

Plaintiffs, two former employees at the Valley State Prison for Women, claim that the warden of the prison at which they were employed accorded unwarranted favorable treatment to numerous female employees with whom the warden was having sexual affairs, and that such conduct constituted sexual harassment in violation of the California Fair Employment and Housing Act (FEHA). (Gov. Code, § 12900 et seq.) The trial court granted summary judgment in favor of defendants, concluding that the conduct in question did not support a claim of sexual harassment, and the Court of Appeal affirmed. We must determine whether, in light of the evidence presented in support of and in opposition to the summary judgment motion, the lower courts properly found that plaintiffs failed to present a prima facie case of sexual harassment under the FEHA.

For the reasons explained below, we conclude that, although an isolated instance of favoritism on the part of a supervisor toward a female employee with whom the supervisor is conducting a consensual sexual affair ordinarily would not constitute sexual harassment, when such sexual favoritism in a workplace is sufficiently widespread it may create an actionable hostile work environment in which the demeaning message is conveyed to female employees that they are viewed by management as “sexual playthings” or that the way required for women to get ahead in the workplace is by engaging in sexual conduct with their supervisors or the management. We further conclude that, contrary to the Court of Appeal’s determination, the evidence presented in the summary judgment proceedings was sufficient to establish a prima facie case of sexual harassment under the appropriate legal standard, and thus that the Court of Appeal erred in affirming the trial court’s grant of summary judgment in favor of defendants.  Accordingly, we shall reverse the judgment rendered by the Court of Appeal.

The court based its reasoning largely on an EEOC policy statement concerning favoritism for sexual partners in the workplace.  (For those interested in regulatory trivia, the policy statement was signed by then-EEOC Chair Clarence Thomas.)

Leaving aside issues of statutory interpretation and legal precedent, this outcome seems like common sense.  If the subordinate having the affair receives tangible employment benefits BECAUSE of the affair, then the implicit message is that those benefits are available only to those having a romantic relationship with the supervisor.  Employees either unwilling or unable to have a romantic relationship are excluded from those employment benefits.  In effect, sex becomes a condition of full employment opportunities in that workplace.  (The state’s regulations defined harassment to include “[u]nwanted sexual advances which condition an employment benefit upon an exchange of sexual favors.”)  This seems like but a small step from quid pro quo harassment, where a supervisor expressly conditions either a benefit or detriment on whether the employee accedes to sexual demands.  Indeed, the EEOC's policy statement says the following about favoritism:

Managers who engage in widespread sexual favoritism may also communicate a message that the way for women to get ahead in the workplace is by engaging in sexual conduct or that sexual solicitations are a prerequisite to their fair treatment.  This can form the basis of an implicit ‘quid pro quo’ harassment claim for female employees, as well as a hostile environment claim for both women and men who find this offensive.

Be Careful What You Wish For

According to an article in today’s Wall Street Journal, one of the federal government’s main initiatives against money laundering and terrorist financing may have become self-defeating.  The problem involves so-called Suspicious Activity Reports (SAR), which federal law requires banks to file when a customer completes a suspect transaction:

Banks have been required to file suspicious-activity reports since a 1992 amendment to the Bank Secrecy Act aimed at catching money launderers and drug smugglers. The Patriot Act expanded the requirement to include looking for signs of terrorist financial activity and increased banks' responsibility for monitoring their customers. It also extended suspicious-activity reporting requirements to brokerage firms, casinos and firms that cash checks or transfer money overseas.

Money-laundering laws also require banks to file currency-transaction reports on any deposit or withdrawal of more than $10,000 in cash. They file about 13.6 million of these reports a year, a number that has stayed consistent because these reports don't involve judgment calls.

The Financial Crimes Enforcement Network (FinCEN) (part of the Treasury Department) overseas the SAR submissions.  As one might suspect, recent high profile cases where banks were dinged for less than diligent SAR practices has caused banks to become a wee bit overcautious:

The government's use of the Patriot Act to force financial institutions to report suspicious transactions has resulted in an avalanche of unwanted paper and computer tapes that officials who collect the data say is undermining efforts to detect money flowing to terrorists.

The government's money-laundering crackdown in the past two years has ensnared a handful of banks that were fined for failing to report suspect transactions. This has prompted executives to file more "suspicious-activity reports" -- the majority of which involve activity that isn't suspicious at all, government and banking officials say.

This defensive filing by banks is clogging the database of the Treasury Department's Financial Crimes Enforcement Network, which collects the reports, say current and former officials of the network, also known as FinCEN.

In 2004, 689,414 suspicious-activity reports were filed, up from 507,217 in 2003 and 281,373 in 2002, FinCEN data show. In the first half of this year, roughly 400,000 reports were filed.

The volume indicates that banks' tactic for avoiding regulatory scrutiny is "to file more reports, regardless of whether the conduct or transaction identified is suspicious," said FinCEN Director William J. Fox in an April report. These defensive filings "have little value, degrade the valuable reports in the database and implicate privacy concerns." Law-enforcement and intelligence officials can get detailed information about individuals from the database without having to request and justify subpoenas.

If you think about it, this reaction is predictable.  The cost to the bank of generating a SAR is relatively slight compared to the potential cost (discounted by the probability) of missing a transaction that, though innocent on its face, turns out to be money laundering or terrorist-related.  The cost and probability are likely exaggerated by a few high profile cases have the banks spooked:

Running afoul of regulators carries risks. In January, Riggs Bank in Washington pleaded guilty to a criminal count of not filing proper suspicious-activity reports involving foreign officials and was fined $16 million; it since has been bought by PNC Financial Services Group Inc. AmSouth Bancorp. of Birmingham, Ala., last year agreed to pay $50 million to avoid criminal charges in a deferred-prosecution deal with the Justice Department for failing to file suspicious-activity reports, including on some transactions used in an alleged Ponzi scheme.

So while FinCEN presses banks to be more selective, the banks say they are being pressured by regulators to report anything that technical criteria suggest may be suspicious, rather than analyzing transactions individually. FinCEN data show that some file reports simply because a customer made heavy use of an ATM or received or sent international wire transfers, or because the bank didn't know the source of deposited money.

And hindsight always being 20-20, the bank will be blamed for missing supposed red flags.  The real cost is on the government regulators who have to wade through this morass of paperwork, because the banks will have done relatively little pre-screening.  Then again, what did the government expect?  This may be one of the few areas where over-compliance is actually cheaper for the regulated than the regulator.  This irony would be funny if it didn’t affect such a serious matter:

The increased volume of suspicious-activity reports "is bad for the war on terrorism," said Steve Bartlett, who heads the Financial Services Roundtable, a financial-services trade group. But "until some alterations are made in the system, I believe defensive filings will get worse."

Bribes, Prosecution, and Compliance

Last week’s Wall Street Journal has an article on the Foreign Corrupt Practices Act (FCPA) that raises a couple of useful compliance lessons.  The FCPA is a federal law that prohibits American (and some foreign) businesses and individuals from bribing foreign government officials to obtain or retain business.  The article explains how GE discovered FCPA violations at a company it wanted to purchase:

In March 2004, GE concluded something was amiss in the books of a company it wanted to buy: California scanner manufacturer InVision Technologies Inc.

GE and InVision discovered as part of a due-diligence review what appeared to be unusual payments. In July, InVision told the Justice Department that its distributors in Thailand might have paid, or might have offered to pay, bribes to officials or politicians to facilitate the sale of 26 scanners valued at $36 million.

Under the U.S. Foreign Corrupt Practices Act, a company can be fined even though no hard evidence is produced to substantiate the suspicion. GE acquired InVision in December, after InVision paid $800,000 in fines to the U.S. government. The company has since been renamed GE InVision, and agreed to cooperate with the Justice Department and Securities and Exchange Commission with any further investigation, as well as surrender $589,000 in scanner profits and pay a further $500,000 fine to the SEC.

GE noted that the Justice Department and SEC investigations focused on InVision's conduct prior to its acquisition. It said GE has cooperated fully with the government probes and since has implemented a rigorous integrity policy.

But the controversy has continued to rumble on in Thailand, despite GE's assurances that no firm evidence of illegal payments was found.

Mr. Thaksin's critics have used the InVision affair to galvanize opposition. The row has caused a damaging rift within Mr. Thaksin's own ruling Thai Rak Thai party, with several prominent members threatening to quit. And it is raising doubts about the administration's ability to prevent corruption in public-work projects.

. . . .

The ambiguity of InVision's admission that it may or may not have paid bribes prompted several Thai agencies to launch their own inquiries to find out whether any kickbacks were in fact paid, and to whom. Analysts say these probes can be taken as an indication of the administration's resolve to curb corruption.

Mr. Thaksin last month publicly demanded that GE InVision clarify that no bribes were paid, or else the $36 million scanner contract would be canceled -- a risky course of action that would have delayed the opening of the new airport.

GE InVision then wrote a letter to the Thai government saying there was no evidence that any bribes were paid to Thai official. The letter was published in Thai newspapers. Separately, last month an official at the U.S. Embassy in Bangkok invited Thai media representatives to a briefing at which they were told the Justice Department also found no evidence that bribes were paid to Thai officials.

Likewise, an official Thai government probe concluded last week there was no evidence that Thai officials took bribes to buy baggage scanners from InVision.

Still, the controversy refuses to go away. The opposition yesterday filed a no-confidence motion against a cabinet secretary allegedly involved in the scanner sale. The Thai Senate's antigraft committee also is continuing its own probe of the scanner deal.

A couple of observations here.  First, while I would not go so far as to say that “a company can be fined [under the FCPA] even though no hard evidence is produced to substantiate the suspicion,” it is true that suspicion alone can put a company on the government’s radar screen.  And given the desire to avoid the adverse publicity from an FCPA investigation or charge, a company may decide to deal with the government despite little more than a suspicion.  Lately, this means that the company may accept a deferred prosecution agreement (DPA) that imposes fairly intrusive measures.  An article in today’s Wall Street Journal notes this development:

Once rare, the threat of criminal indictment of corporations themselves has become more common as the Justice Department employs what are known as deferred-prosecution agreements. A list of blue-chip American companies have submitted to these pacts, including American International Group Inc., Monsanto Co. and Time Warner Inc. Under the arrangements, the government charges the company with criminal behavior but puts the prosecution on hold in exchange for a promise of reform. At an agreed-upon date, the potential charges expire. Since 2003, there have been at least eight such pacts.

Earlier this year, the Department of Justice entered a DPA with Monsanto Corporation over alleged FCPA violations.  According to the DOJ press release, the agreement included this requirement: “An independent compliance expert will be chosen to audit the company’s compliance program and monitor its implementation of and compliance with new internal policies and procedures.”  So, the lesson is that poor FCPA compliance can lead to the government taking over your compliance program.

Now, a second observation.  The article points up the dangers of dabbling in bribery abroad.  A company might be tempted to pay bribes because (a) it is the only way to land that big foreign government contract, and (b) no one will ever know because, after all, the government I am bribing doesn’t care.  Well, of course, things can change.  As the article above describes, if the bribe comes to light, the people who received the bribe might either get religion and become ultra-anti-corruption or simply get tossed from office.  Either way, the bribe payer becomes the scapegoat.