Corporate Law Adviser – Justification of Criminal Sanctions For Violations of Corporate Governance

Introduction

1. Corporate governance is concerned with the separation of ownership and control that results when a company is publicly listed and, therefore, has too many owners who cannot all control the company at once, and as such, they hire professional managers to do so. It has been defined, thus:
“The system through which those involved in the company’s management are held accountable for their performance, with the aim of ensuring that they adhere to the company’s proper objectives”.

It is generally accepted that the law plays a key role in corporate governance particularly in the provision of shareholder protection and the reduction of expropriation that is the result of the separation of ownership and control. However, on the importance of role of criminal law in enforcing good corporate governance there are more than one view. Effectiveness of criminal sanctions in deterring corporate governance violations.

2. In order to deter certain undesirable conduct, the criminal law has traditionally employed such sanctions as imprisonment, fines, and the stigma of criminality. While the effectiveness of these sanctions in criminal law generally has been debated, it has been persuasively argued that they can effectively deter corporate crime. Since corporations are primarily profit seeking institutions, they choose to violate the law only if it appears profitable. Profit maximising decisions are carefully based upon the probability and amount of potential profit, so a corporate decision to violate the criminal law would generally include a calculation of the likelihood of prosecution and the probable severity of any punishment. Making these costs sufficiently high should eliminate the potential benefit of illegal corporate activity and, hence, any incentive to undertake such activity.

2.1 Improper corporate conduct could be deterred by applying criminal sanctions either to the corporation itself or to its officers and employees. A corporation cannot, of course, be imprisoned but there may be stigma of criminal label attached to it. Such stigma could influence corporate behaviour if it led to diminished profits.

2.2 A system of fines imposed on corporations should also adequately deter illegal corporate activity as long as the fines are large enough to force the corporation to disgorge all benefit gained from illicit conduct.

2.3 It is possible to deter corporate misbehaviour by applying criminal sanctions to individuals in the organisation. Since businessmen fear the stigma of criminality for both personal and economic reasons, such penalties might be effective deterrents. Indeed, the fear of criminal indictment or investigation, even in the absence of conviction, may effectively deter corporate officials.

2.4 Corporate civil sanctions and even individual civil fines will be inadequate when an individual is motivated to violate the law by reasons other than corporate benefit. He may seek, for example, to enhance his position within the corporation or even to use his position to violate a law which he believes is unjust. Thus, any additional deterrence which is needed to supplement a system of civil fines could only be obtained by imposing criminal sanctions on such blameworthy behaviour by individuals.

2.5 Criminal law also empowers other law abiding individuals – whether the Board of directors, senior management, or other professionals – to stand up to less well intentioned colleagues or, at a minimum, to resist going along with misconduct.

2.6 The survival and long-term profitability of corporations is no longer a private interest which merely affects those who deal with the corporation at a primary level, for instance investors, but also a public interest affecting the welfare of stakeholders such as employees to whom it provides jobs and pensions. The Government, therefore, has a responsibility to ensure that employees as well as other stakeholders of the corporation are protected from the fraudulent acts of managers who do not act in the best interests of the company. The success of the corporation is, therefore, a public interest that, to a certain degree, ought to be protected through State regulation.

2.7 Research has confirmed that criminal sanctions are the only mechanism that can protect investors from large scale fraud or theft. Every country uses harsh criminal punishments to deal with cases like Enron and Parmalat. This suggests that criminal punishment is a generally accepted way of protecting shareholders from expropriation and risk-taking in corporate governance.
Dangers in the application of criminal sanctions

3. Some commentators have expressed doubts about the effectiveness of criminal sanctions for violation of good corporate governance. They believe that the criminal sanctions to corporations and individuals are ineffective deterrents to violations of good corporate governance norms.

3.1 The use of criminal sanctions to regulate business activities is generally perceived as being an over-reaction that is likely to discourage directors from taking the risk that is necessary to run a business, thereby slowing down economic growth and interfering with profitability.

3.2 The use of criminal sanctions is an expensive way of enforcing regulation, which has a high burden of proof and as such is prohibitive to those seeking remedies for expropriation, as shareholders are required to demonstrate the director’s culpability.

3.3 Criminal sanctions cannot provide restitution to shareholders and employees who have lost their jobs.

3.4 The difficulty in pinpointing responsible persons in the corporate structure lessens the likelihood that a businessman will in fact be convicted of criminal activity. Thus, corporate crime may not be adequately deterred by criminal sanctions designed for individuals.

3.5 The criminal law is being used to regulate behaviour that is not in and of itself morally blameworthy and in some cases imposes sanctions in the absence of fault. The use of criminal sanctions for purely regulatory purposes represents a severe departure from the traditional aims of the criminal law-deterrence and retribution.

3.6 The type of activity which results in criminal liability in the corporate setting is different from other criminal activity; the primary concern is often with the supervisors and managers rather than with the direct actors. Thus, corporate officials may be held liable for acquiescing in, or for recklessly or negligently tolerating, the illegal activity of subordinates.

3.7 Criminal sanctions are imposed on a corporation, an artificial entity which can possess no state of mind, in the absence of some theory which ascribes fault to the corporation itself, rather than only to its officers, directors, and employees, the concept of mens area in criminal law is itself challenged.
Conclusion

4. Given the range of policy issues raised by corporate governance, and variety of industries and firms involved, government decision makers will need to understand thoroughly the effects that different regulatory actions can have. There are arguments both in favour and against the use of criminal sanctions to be imposed against the violators of corporate governance norms. As per the existing laws of our country there are various provisions fixing the criminal liability of the wrongdoers in cases of fraud and misconduct, etc. Indian Penal Code affixes penal liability for any fraud or breach of trust committed by the companies and even various individual sections of the Companies Act impose penalties for violations of certain norms which are part of good corporate governance.

But these provisions have merely remained on paper and their implementation has often remained a big headache for the government. However, scandals and scams such as Satyam’s case have been a reality even in the present times. Even though section 23E of the Securities Contracts (Regulation) Act, 1956 imposes penal liability on the company for any violation of the condition of listing agreement, which includes clause 49 of the Listing Agreement and relates to corporate governance, but the fact remains that such liability is imposed on the company itself which directly affects the stakeholders in the company and are in fact the real victims of violation of good governance.