We take a break from our many posts on the SEC's current proposals to amend Rule 14a-8, the shareholder proposal rule. We will resume next week, focusing on the alternative proposal that would amend Rule 14a-8 to prohibit, in some instances, the exclusion of a bylaw requiring the inclusion of shareholder nominees in the company's proxy statement. This is the so called access proposal. For now, we return to another common theme of the Blog, corporate governance and the impact of SOX.
SOX attempted to reduce the instances of false disclosure by giving gatekeepers such as accountants and the audit committee of the board more authority and greater involvement in the disclosure process. But as the criminal action against Chiquita Brands International shows, there are limits to this method of reducing improper behavior. Sometimes even when the gatekeepers know what is going on, the activity continues.
As we have already written, Chiquita agreed in March 2007 to plead guilty to one felony for making payments to a terrorist organization in Colombia. We have obtained a copy of the Government Sentencing Memorandum in the case and it is posted on the DU Corporate Governance web site. The sentencing hearing was held on Monday, Sept. 17, 2007 and the plea approved.
Chiquita operated a subsidiary in Colombia that produced bananas. According to the Sentencing Memorandum discloses, Chiquita "paid money to [the AUC] a violent, right-wing terrorist organization in the Republic of Colombia" over a six year period, from 1997 through Feb. 4, 2004. Along with other organizations, it was "responsible for a staggering loss of life in that country."
How often were the payments made? "Defendant Chiquita paid the AUC, directly or indirectly, nearly every month. From 1997 through February 4, 2004, defendant Chiquita made over 100 payments to the AUC totaling over $1.7 million."
What was the impact of the payments? Again, according to the Sentencing Memorandum:
"The money that defendant Chiquita paid to the AUC (and to the FACRC and the ELN before that) was put to whatever use the terrorists saw fit. Money is fungible. Regardless of the Company's motivations, defendant Chiquita's money helped buy weapons and ammunition used to kill innocent victims of terrorism. Simply put, defendant Chiquita funded terrorism."
Was this something done by low or mid level employees without management's awareness? That once it became known to management, the practice came to an end? Not quite. Again, the Sentencing Memorandum:
"Defendant Chiquita continued to pay the AUC even after the payments were brought directly to the attention of its senior executives during a Board meeting held in September 2000."
"Defendant Chiquita continued to pay the AUC after gaining direct knowledge of the AUC's designation as a Foreign Terrorist Organization in September 2002."
"Defendant Chiquita continued to pay the AUC even after its outside counsel emphatically and repeatedly advised the Company, Beginning in late February 2003, to stop the payments."
"Defendant Chiquita continued to pay the AUC after Department of Justice officials admonished the Company, on April 24, 2003, that the payments were illegal and could not continue."
"Defendant Chiquita continued to pay the AUC even after one of its directors acknowledged in an internal email, on December 22, 2003, that 'we appear [to] be committing a felony.'"
And the Company's motivations? As the Memorandum noted, "Defendant Chiquita claimed that it made the payments to protect its employees." But at the same time, the Memorandum made these comments:
"Defendant Chiquita's reason for being in Colombia was, of course, to produce bananas profitably. And there is no question that defendant Chiquita profited from its Colombian operations during the period that the Company paid the AUC. According to defendant Chiquita's records, from September 10, 2001 (the date of the AUC's designation as a Foreign Terrorist Organization), through January 2004, the company earned approximately $49.4 million in profits for its Colombian banana-producing operations. Indeed, by 2003 the Company's Colombian operations were its most profitable."
Said another way, the Sentencing Memorandum described the attitude towards the payments, at least in the beginning, as a "cost of doing business."
"Whatever motivated defendant Chiquita at the start, the Company made a business decision to remain in Colombia and pay the AUC for over six years. Officers of defendant Chiquita and Banadex [the Colombian subsidiary] referred to the payments as an unsavory 'cost of doing business' at their inception in 1997. When the internal investigation about the payments was presented to the board in September 2000, the Board treat them as a routine business matter -- a tolerable expense to be kept low."
The penalty for this behavior? A $25 million fine, to be paid in five annual installments, and corporate probation of five years. The maximum potential fine was $98.8 million, but that was based upon the $49.4 million in profits earned from Sept. 10, 2001 through January 2004. In other words, the one count and the determination of the fine did not take into account the payments made or profits earned from 1997 through September 9, 2001. Credit was given for self reporting the offense, although the Memorandum noted that "defendant Chiquita also admitted as part of its guilty pleas that it continued to engage in the same criminal conduct after its voluntary disclosure."
What about the responsible individuals inside the Company? The Memorandum emphasized that it "was particularly important to make clear that the conduct that lead to the Company's guilty plea was not the act of a rogue employee or mid-level manager." In other words, it was known at the highest levels within the Company. Nonetheless, with respect to additional charges in the matter, "the United States has decided not to do so" out of an exercise of prosecutorial discretion.
What are some of the consequences? Law suits, of course, but not just the usual ones brought by unhappy shareholders. According to the Company's most recent quarterly report:
"Three separate lawsuits have been filed against the company in U.S. federal court claiming that the company is liable for alleged tort violations committed in Colombia. The first lawsuit was filed on June 7, 2007 in the U.S. District Court for the District of Columbia; the second was filed on June 13, 2007 in the U.S. District Court for the Southern District of Florida; and the third, a proposed class action, was filed on July 18, 2007 in the U.S. District Court for the District of New Jersey. The plaintiffs in all three suits claim to be, or claim to be members of a class of, family members or legal heirs of individuals allegedly killed by armed groups that received payments from the company’s former Colombian subsidiary. The plaintiffs claim that, as a result of such payments, the company should be held legally responsible for the death of plaintiffs’ family members. The lawsuits seek unspecified monetary damages. The company believes it has meritorious defenses to the plaintiffs’ claims and intends to defend itself vigorously against the lawsuits."
The facts in this case seem egregious. In connection with the claims that the payments were meant to protect employees, the Sentencing Memorandum poses a series of unanswered questions that suggest otherwise. Moreover, despite the claim, the payments came to a quick end once the will existed at the top levels of the Company. It was the arrival of Fernando Aguirre as CEO in January 2004 that ended the practice. One month after assuming office, he decided that the payments had to stop, concluding in an email to senior officers: "At the end of the day, if extortion is the modus operandi in Colombia or any other country, we will withdraw from doing business in such country." Chiquita sold the Colombian subsidiary about five months later. It is entirely unclear what prevented Chiquita from taking the same path years earlier.
As for matters of corporate governance, boards have a fiduciary obligation to profit maximize. Profit maximization is a concept that requires exclusive focus on the interests of shareholders, not the broader community. Fortunately, this duty does not apply where it means engaging in illegal activities. See Miller v. AT&T, 507 F.2d 759 (3rd Cir. 1974). The facts in Chiquita show why. There are time when engaging in unsavory activity can be highly profitable.
SOX sought to avoid fraud through a two prong approach that both increased the involvement of gatekeepers in the disclosure process and imposed stiff penalties for violations (witness the potential 20 year prison terms for violations of the certification requirement by the CEO or CFO). By making individuals responsible, it provides far greater incentive to ensure proper disclosure. The value of this approach can be seen from Chiquita, where none of the individuals responsible for the behavior were prosecuted and the Company was subjected to a modest financial penalty. Whatever can be said about the Chiquita incident, the results provided little deterrence to other companies in a comparable situation.