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Tuesday, February 21, 2012

Offensive Compliance

We ordinarily think of the corporate compliance department as a defensive unit within the corporation. Compliance personnel utilize a variety of investigatory tools and reporting processes to help defend the corporation from internal and external threats.

But compliance can also be used offensively.  Boards and corporate managers can direct investigators to search for "dirt" in order to force governance changes internally, or perhaps stave off external threats such as a takeover by a hostile suitor.  Suddenly, compliance no longer looks so virtuous. (For an earlier discussion of the darker implications of compliance, see my discussion of Hewlett Packard here.)

For an example of offensive compliance, one need only glance at the turmoil brewing within Wynn Resorts, the purveyor of fancy casinos throughout the world. Recently, Wynn's 20% shareholder, Kazuo Okada, sued Wynn in Nevada for the release of records relating to Wynn's $135 million donation to the University of Macau. Wynn's Board, meanwhile, was upset with Okada because his company was building its own casino in the Philippines, thereby competing with Wynn in Asia.  

If your 20% shareholder flexes its competitive muscle and then sues you noisily for making a large donation to a foreign university (thereby triggering an informal SEC investigation), you've got a governance problem. How do you solve it?

If you have a provision in your corporate charter that permits a redemption of shares of any person who the Board finds "unsuitable" (see the paragraph at p. 142 - intended to preserve gaming licenses), the answer is simple: you pay the former director of the FBI to conduct an investigation of your shareholder.  Since the target of your investigation is itself a multinational corporation, your investigator undoubtedly focuses on possible violations of the Foreign Corrupt Practices Act.  When his report turns up evidence that said shareholder made some questionable payments to local officials in the Phillipines (in the form of complimentary accomodations and the like), you go public with the evidence and then invoke the language of your charter provision, which permits the company to redeem the stock of any "unsuitable" person at "fair value."  This removes your governance problem.  It also may permit you to buy your shareholder out at a discount if you can explain that the resulting price is "fair", since your charter warns as much.  Sure, your shareholder will probably sue you, but he'll have to explain away those FCPA allegations too.  If the market believes your investigator, your shares will probably rise.    

Is offensive compliance a positive development?  My intuition tells me "no" although I want to think about the topic more carefully over the coming months.  On the upside, it demonstrates ways in which incentivized boards and shareholders can police each other, thereby deterring violations of law.  Under this narrative, compliance isn't simply a requirement in which the Board reluctantly invests, but a potentially useful tool that the Board eagerly embraces.  

On the downside, offensive compliance can trigger a number of long-term costs for shareholders and society.  Instead of debating corporate policy and solving problems, everyone spends money and time investigating and fighting with each other.  In short, offensive compliance generates and exacerbates internal corporate conflict.  It's difficult to call this a positive outcome, particularly over the long run.  

In any event, as the Wynn scenario demonstrates, offensive compliance yields information, and information can be quite valuable when delivered to the right hands.  To that end, we should not expect it to disappear any time soon.  

Posted by Miriam Baer on February 21, 2012 at 12:36 PM | Permalink


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