Legal Hazard: Corporate Crime, Advancement of Executives' Defense Costs, and the Federal Courts (Part I)
Peter Margulies | Roger Williams University
Posted Monday, December 4, 2006
7 U.C. Davis Bus. L.J. 2 (2006)

Seemingly innocuous legal arrangements driven by cash and conventional wisdom can conceal serious risks. The indemnification of executives for the consequences of criminal charges brought against them has become a mainstay of corporate life for the last fifty years.[1] Hidden underneath the mainstream practices of indemnification and Director's and Officer's (D & O) insurance, which often include the advancement of legal fees, is an interlocking web of assumptions that should trouble champions of sound corporate governance and legal ethics. Federal prosecutors and regulators have recently begun to look more critically at these practices and their connection to business crime.[2] This scrutiny by enforcement agencies has provoked a fierce response from an American Bar Association (ABA) Task Force.[3] It also prompted a federal court to strike down portions of the guidance prosecutors receive.[4] This article argues that advancement, indemnification, and insurance raise concerns about excessive executive compensation,[5] obstruction of justice, and conflicts of interest.[6]

The corporate scandals of the last five years have revealed a disturbing landscape of errant managers and indifferent boards of directors.[7]. These problems often result from four factors: agency costs, moral hazard, the race to the bottom, and cognitive biases. Agency costs arise when the corporation's agents, such as directors and executives, transact business at less than arm's length, causing harm to shareholders.[8] Agency costs that pervade the provision of executive perquisites such as corporate jets and backdated stock options[9] also drive the corporate subsidy of executives' legal fees.[10] These fees act as an indeterminate form of payout to managers with no link to performance.[11] In addition, subsidy of attorney's fees, D & O insurance, and indemnification induce moral hazard, encouraging conduct that injures the corporation by insulating executives from accountability.[12] Scandal-plagued corporations also reveal a "race to the bottom" dynamic,[13] where aggressive financial and accounting practices crowds out scruples, and corporations rush to offer packages including indemnification, insurance, and advancement to this week's manager of the moment. Additionally, cognitive biases that shape discourse[14] marginalize staid metrics such as price-earnings ratios,[15] and insist that indemnification and other protections are crucial for meeting modern business challenges.[16] Finally, a corporation's advancement of legal fees to managers can create conflicts of interest for lawyers since the defendants' cooperation with the government can jeopardize the interests of the entity paying the bills.[17]

These problems would be less serious if regulation of business practices deterred misconduct. However, commentators agree that government regulation was ineffective in deterring the recent wave of abuses such as those that occurred at Enron.[18] Similarly, practices such as advancement of legal fees, indemnification, and insurance have blunted corporations' internal controls that could prevent these problems.[19]

It was not always this way. During the New Deal, unlimited advancement of legal fees was neither necessary nor natural.[20] Commentators from the New Deal era had seen the excesses of managers help ignite the Great Depression, and they recognized that adding subsidy of legal fees and related promises to executive compensation could undermine accountability.[21] Courts followed suit, viewing these practices as wasteful and at the expense of voiceless shareholders.[22] Gradually, however, the tide turned, and advancement has become a part of modern corporate management.[23] Events like the Enron scandal, however, suggest that the New Dealers' view is the better one.

The federal government recently sought to redress the underenforcement of corporate criminal laws, a practice that contributed to the Enron scandal, with a declaration of principles and best practices for prosecution of corporations. Known as the Thompson Memorandum,[24] the declaration states corporate criminal prosecution is appropriate where misconduct is pervasive and either condoned, facilitated, or directly committed by senior management.[25] Federal enforcement policy now expressly recognizes the possibility of problems in "corporate culture."[26] Where managers have engaged in pervasive wrongdoing, prosecutors should indict the corporation unless it promises to cooperate fully with the investigation, and is now committed to compliance with the law.[27] Prosecutors may also consider whether the corporation is advancing legal fees to individual executives[28] in a fashion that stymies cooperation, or treating executives who engaged in wrongdoing with inappropriate leniency.[29]

The new federal enforcement policy inspired a vigorous response from commentators, the organized bar, and the courts. However, the critics' insight does not match their indignation. In United States v. Stein,[30] the court ruled that the Thompson Memorandum's recommendation that prosecutors scrutinize corporate practices regarding advancement of legal fees violated the Fifth and Sixth Amendments. The court ignored how advancement of legal fees increases agency costs and moral hazard, encouraging corporate misconduct. In a subsequent decision suppressing statements made to prosecutors,[31] the court disregarded both the government's interest in obtaining cooperation and an organization's right to terminate an employee who refuses to cooperate with an investigation.[32] Moreover, the court claimed ancillary jurisdiction to decide disputed legal fees, ignoring difficult issues of state law that the court should have left for state courts to resolve.[33]

Critics of the shift in federal enforcement fail to respect the interdependence of commitments required for sound governance in the corporate arena. Prosecutors need the freedom to set conditions for defendants' cooperation to facilitate efficient investigations and prevent future wrongdoing. Cooperation is particularly important in the corporate arena, where serpentine paper trails and a multiplicity of players increase the risk of cover-ups. Limiting legal fee subsidies reduces opportunities for stonewalling and furthers the public interest by increasing effective prosecutions. These prosecutions in turn showcase the government's determination to increase enforcement of corporate criminal laws.

The renewed commitment to civic governance has positive implications for corporate governance. Courts and commentators have recognized that government's willingness to enforce legal norms promotes robust business self-regulation. While some argue corporations cooperate only to save themselves from harm, companies that reduce the agency costs and moral hazard triggered by fee subsidies are also advancing the interests of shareholders. As Judge Friendly observed, self-interest does not undermine change; it enhances the momentum for reform.[34] A corporation that caps fee subsidies in criminal proceedings reduces agency costs and moral hazard, while preserving its ability to attract executive talent. State courts can contribute to improved corporate governance by construing contracts regarding legal fee subsidies in favor of the corporation.

Federal courts can assist in this process by avoiding the Stein III court's expansion of ancillary jurisdiction. This amorphous jurisdiction often immerses the tribunal in contractual disputes where state courts and arbitrators have superior expertise. Moreover, under the Erie doctrine, federal courts should follow state law on these matters but may be tempted to rule otherwise if it makes the criminal case easier to manage.[35]

The article is in five parts. Part I discusses the catalysts for corporate insider misconduct: agency costs, moral hazard, cognitive bias, the race to the bottom, and lax government enforcement. Part II argues that a corporation's subsidy of legal fees and indemnification agreements clashes with legal ethics as the corporation may require attorneys to contest charges even though the defendant may benefit from a plea deal. Part III discusses the government's attempt to strengthen enforcement through the Thompson Memorandum. Part IV describes the response to the government's enforcement initiatives, in particular the Stein Court's view on fee subsidies. Part V discusses the interaction between civic and corporate governance on fee subsidies, and the appropriate stance of federal courts.


The malfeasance of executives is a function of organizational and corporate culture. While countless corporations are healthy and contribute to social wealth[36] and the public welfare,[37] corporate insiders at some companies have perpetrated frauds that cost shareholders tens of billions of dollars. Underenforcement of rules prohibiting such abuses further compounds the problem.

a. Problems of Collective Action and Cognitive Bias in Corporations

Corporations plagued by executive malfeasance also suffer from pathologies of collective action and social cognition.[38] These include agency costs, moral hazard, the race to the bottom, and cognitive biases. An example from the most publicized recent corporate scandal provides a context for understanding these factors.

Consider the conduct of Andrew Fastow, CFO at Enron, in creating Special Purpose Entities (SPE's).[39] The myriad partnerships Fastow formed were not independent of the corporation, as the law requires,[40] and had no net economic benefits for Enron. Instead, Fastow's SPE's served an accounting purpose, enabling the corporation to minimize the transparency of its financial structure, and conceal the volatility of its underlying core trading business.[41] Moreover, Fastow reaped substantial personal financial benefits from his role in coordinating the establishment and maintenance of SPE's - all at Enron's expense.[42] Fastow and Enron's lawyers developed a constellation of specious rationales, such as the placement of deals with the "fortuitous" timing of bridging two calendar years, and the remote possibility that Fastow would have to contribute to one of the entities, for failing to disclose Fastow's compensation in corporate statements.[43] Fastow and the other Enron employees and outside attorneys developed these rationales despite Fastow's acknowledgment that the amounts he was receiving were substantial enough to be "material."[44] Subsequently, Fastow, Ken Lay, and others sold shares in the company, even as they urged the public to continue investing in Enron, and the employees' pension was "locked down" to prevent them from selling their Enron stock.

Debacles like those that happened at Enron reveal four cardinal flaws in organizational culture.[45] Under the law of agency, agents such as corporate executives must conduct themselves in a fashion that benefits the principal, i.e., the corporation.[46] Unfortunately, corporate fiduciaries may disregard these norms and engage in self-dealing at the corporation's expense. Turning agency principles on their head, corporate insiders look for ways that the corporation can benefit them, such as the deals Enron struck with SPE's in which Enron bore the lion's share of the risk while corporate insiders profited.[47] Even where managers have not engaged in such egregious conduct, business decisions often seem driven by agendas that do not place the corporation first. For example, executives may ask for extravagant compensation packages and benefits, like private jets, that do not reflect executive performance or corporate needs.[48]

When top managers can engage in self-dealing, subordinates and outside professionals hired by those managers display "race to the bottom" behavior.[49] In any situation where pressures to engage in wrongdoing exceed the probable costs of misconduct, actors who resist the temptation to cut corners are placed at a disadvantage.[50] Those managers who accept more aggressive legal interpretations and less transparency to investors thrive in the competitive marketplace.[51] Those with scruples, or a longer-term view of the interests of the corporation, abandon the field.

The set of policies and practices put in place by errant managers reinforce this short-term perspective. When managers can depend on "golden parachutes" to support their life-styles even if they no longer work for the company, "moral hazard" skews managers' decision-making.[52] Lucrative severance packages become particularly problematic, making short-term thinking more likely, and effectively insulating managers from the consequences that the corporation will suffer based their aggressive management directives. As a result, managers take risks that they would avoid if they were more accountable.

Where instrumental factors discourage scruples and encourage a short-term view, cognitive biases soon follow.[53] Groupthink is the result. Once a discourse becomes dominant, cognitive biases frame perceptions. Salient concepts such as the irrelevance of price/earnings ratios to corporate wellbeing distort the marketplace of ideas, constraining debate. This environment of relentless cheerleading marginalizes dissenters as those who don't "get with the program."[54] At Enron, for example, subordinates and outside professionals may have neglected to disclose wrongdoing or discuss potential problems as doing so would have branded them as followers of old discourses and ancient metrics that Enron culture had supposedly transcended.

b. Underenforcement in the Governmental and Corporate Arenas

The organizational culture that produces misconduct by corporate executives would be less troubling if executives were accountable for their transgressions. Unfortunately both legal and internal corporate controls have failed in cases of egregious executive misconduct. The lack of accountability exacerbates the problem of moral hazard and makes government a tacit accomplice in the loss of shareholder value.

i. Government Underenforcement of Norms Constraining Corporate Insiders

Underenforcement is a chronic problem in the context of corporate insider wrongdoing.[55] Managers who wish to insulate themselves from accountability have formidable weapons at their disposal. Regulated industries have on occasion captured the agencies designed to regulate them. In addition, populist pressures that skew the political calculus of Congress toward ever-higher penalties for street crime work intermittently in the corporate crime arena.

Business groups have often found the legislative climate favorable for rolling back remedies enjoyed by shareholders and the public. The accounting profession championed the Private Securities Litigation Reform Act of 1996,[56] which made it more difficult for plaintiffs to hold accountants liable for material inaccuracies by issuers.[57] Influential legislators received substantial campaign contributions from the accounting industry to support this measure.[58] Enforcement actions against auditors brought by the SEC also declined due to a paucity of resources.[59] The Supreme Court contributed to this trend by holding that the securities laws did not encompass "aiding and abetting" liability.[60] These developments in turn reduced incentives for accountants to remain vigilant in the face of corporate insider depredations such as those that led to the Enron scandal.[61] Subsequent statutory developments, such as the Sarbanes-Oxley Act, have a salutary purpose, but may furnish too little regulation in important areas and too much legal regulation in areas where self-regulation is appropriate.

Moreover, Congress historically has focused more on street crime, particularly drug offenses, than on white-collar crime. In the drug offense arena, political dynamics create an alliance between legislators and prosecutors that ensures vigorous enforcement. Legislators increase criminal penalties, to demonstrate their tough stance on street crime and counter attacks by political opponents.[62] In contrast, the political dynamic for white collar criminal enforcement is much more fickle.[63]

The operational features of white collar crime also blunt enforcement. White collar crime often involves complex financial transactions where the "money trail" is exceedingly difficult to trace. Moreover, the sophistication of the personnel involved makes "smoking guns" rare. In addition, the phenomena discussed in Part I make the participants in such conduct dependent on one another in a way that is difficult to disrupt.

Resource constraints of enforcement agencies also play a role. Government budgets are limited, and the enforcement capacity of agencies like the SEC or the IRS cannot keep up with the volume of potential crimes.[64] These agencies depend on good will and voluntary compliance from those whom they are regulating. Wrongdoers use the asymmetry between the volume of transactions and the level of enforcement resources to escape detection and prosecution.[65] In the tax setting such wrongdoing also reduces taxpayer resources, and hampers the ability of the market to disperse information. In this sense, corporate insider wrongdoing is doubly destructive.

In keeping with the structural dynamic that favors underenforcement, the government has failed to consistently punish conduct by corporate insiders.[66] Historically, in cases involving corporate giants such as the Standard Oil Company, prosecutors have focused on price-fixing.[67] In areas such as consumer safety, however, the government has encountered difficulty in using the criminal law to deter and punish decisions by corporate executives. One example of this was Ford's decision in the 1970's to use cost-benefit analysis as a rationale for refusing to fix a defectively designed gas tank on its Pinto automobile. A jury acquitted Ford, which had mounted a vigorous defense with a skilled trial attorney, and the company has continued to sell millions of cars.[68]

Recent high-profile indictments in the financial services industry reveal a more robust approach by prosecutors, but fail to show a decisive turn toward enforcement. A few prominent businesses indicted for fraud or related offenses have dissolved, but for most corporations nothing has changed.[69] Some commentators and practitioners, distressed by these developments, have described a federal indictment of a corporation as a "death sentence."[70] However, empirical observation tells a more nuanced story. In cases where companies took steps, such as changes in management, that demonstrated insight into past problems and a commitment to reform, prosecutors declined to indict, and the firms survived. [71]

ii. Obstacles to Effective Self-Regulation

Underenforcement would be less troublesome if corporations had effective self-regulation. Internal sources of accountability, such as actions by boards of directors or proxy contests, are notoriously weak methods of regulation. Board members often lack independence from managers.[72] In-house and outside legal counsel similarly fail to prevent egregious misconduct. In the Enron scandal counsel asked questions about dubious practices only intermittently, and contented themselves with specious answers from management.[73] While corporate lawyers have successfully pushed for more latitude in the ethics rules to make disclosures that prevent substantial financial harm caused by client fraud,[74] the record of lawyers in past disasters suggests that they do not always comply with existing requirements, such as the obligation to withdraw upon learning that clients are using their services to facilitate illegal conduct.[75] Lawyers for shareholders suing management often generate agency costs of another kind, reaping substantial benefits without clear returns to the shareholders themselves.[76] Finally, as I discuss in the next section, corporate practices, such as the subsidy of executives' legal fees, exacerbate this lack of accountability.


Corporate subsidy of executives' legal fees compounds agency costs and moral hazard, and conflicts with both legal ethics and substantive law. Despite these tensions, fee subsidies, indemnification, and insurance are commonplace in the boardroom and the executive suite. This Part explains the risks posed by these pervasive practices, as well as the factors that drive their continued popularity.[77]

a. The Insurance Paradigm: Hidden Costs and Conflicts

To understand the challenges for legal ethics and substantive law that can stem from a third party paying legal fees and other costs for a client accused of wrongdoing, it is useful to start with the paradigm of simple liability insurance. Liability policies frequently impose a duty upon insurance carriers to defend the insured against a range of legal claims involving negligence and strict liability.[78] In the most familiar insurance context, an average person purchases an insurance policy on the open market, such as a policy covering automobile collisions. The arm's-length nature of this open-market transaction has one salient premise and one cardinal legal consequence. The premise is that the insurer is not a party to the case and the acts of the insurer virtually never figure in the facts underlying the legal dispute. Indeed, rules of evidence seek to insulate the trier of fact from any knowledge of the insurer's existence.[79] The legal consequence of the average policyholder's purchase of an insurance policy is that the law regards the policyholder as the weaker party to the transaction, and therefore often construes any ambiguity in the policy in favor of the policyholder.[80]

However, even in this relatively straightforward context, insurance creates a thicket of problems for both a lawyer representing the insured in a dispute and the insurer. Professional responsibility issues tend to arise when a lawyer paid by an insurer encounters tension between her role as counsel for the insured and the insurer's desire to secure information that could allow it to justify denial of coverage.[81] In such situations, the lawyer should decline to provide the coverage-related information, based on the lawyer's duty of confidentiality to her client.[82] A lawyer who divulges such client-related information to retain the good will and financial compensation from the carrier creates a conflict of interest that materially limits her ability to represent her client.

Another concern, long recognized by scholars, is that insurance can engender "moral hazard," defined as encouragement of irresponsible conduct.[83] People or entities held harmless for errors or wrongdoing have fewer incentives to conform their behavior. As a result, insurance can become a kind of license fee for bad actors. To control the proliferation of moral hazard, insurers often engage in robust loss prevention strategies, such as writing coverage exclusions requiring the use of seat-belts and other safety devices.[84] Liability insurers also seek to limit the moral hazard problem by excluding coverage of intentional acts, including violent crime or fraud. Such exclusions reflect concern that intentional wrongdoers are more likely to game the system by partially immunizing themselves from the consequences of wrongful acts, thereby undercutting the deterrent effect of criminal penalties.[85]

b. The Perils of Subsidy of Legal Fees by Other Potential Parties to the Case

While the problems posed by ordinary open-market liability insurance are significant, the payment of legal fees to an alleged wrongdoer by another party to the case raises even more serious concerns. In this context, both substantive law and professional responsibility norms raise a red flag. While these norms do not bar such payments, which have proliferated in the indemnification of business executives, they indicate that courts and lawmakers should be aware that agency costs, moral hazard, cognitive biases, and race to the bottom issues pose an array of risks.

Participant subsidies of the kind described above can raise substantial concerns under governing substantive law. Consider payment of the legal fees of an alleged mob associate by an organized crime enterprise. Substantive law, such as the federal Racketeering Influenced and Corrupt Organizations Act (RICO), considers such subsidies as "benefactor payments" that tend to prove the existence of racketeering.[86] Fee subsidies of this kind create a moral hazard that exceeds the risk posed by ordinary open-market insurance. Ex ante, payment of legal fees by a racketeering organization encourages mob associates to commit illegal acts, secure in the knowledge that the organization's lawyers will work to hold them harmless. Ex post, an associate's acceptance of such subsidies, along with an attorney handpicked by the organization, is a signal to the organization of one's loyalty[87] - a pre-commitment device that hinders the individual's ability to inform on his colleagues.[88]

In addition, the organization's recruitment of a "stable" of lawyers for its associates can affect the integrity of the legal profession, making the lawyers dependent on the good will of the organization, even when maintaining this good will undermines the detachment from the client necessary for proper performance of the lawyer's role.[89] For example, in United States v. Gotti,[90] lawyers retained by the allegedly corrupt organization failed to point out that a proposed strategy of non-cooperation with lawful grand jury subpoenas might constitute obstruction of justice. In such white collar cases, evidence suggests that key lawyers for the organization maintain a constellation of other lawyers dependent on referrals, and are therefore inclined to recommend against a defendant's cooperation with the government, even when cooperation might be in the defendant's best interests.[91]

Payment of legal fees can also affect the integrity of the legal system, if resources used to pay fees were accrued as a result of illegal behavior. Federal and state fee forfeiture laws seek to guard against this risk, by requiring the forfeiture of legal fees upon proof that parties paying the fees obtained the means to pay through illegal conduct.[92]

c. Fee Subsidies in the Corporate Arena: The Worst of Both Worlds

Corporate subsidy of criminal defense fees combines the moral hazard of insurance and the agency costs of bloated executive compensation. Suppose that senior managers of a corporation act in concert to commit illegal acts. Corporate by-laws, contracts, or insurance policies that advance legal fees or indemnify executives for other costs promote moral hazard by providing protection against the consequences of breaching legal norms. Moreover, as in the organized crime milieu, advancement of legal fees to executives promotes loyalty to the conspiracy, and prevents the government from "peeling off" players who might wish to cooperate with the prosecution.[93]

Subsidies by corporations also feature the confluence of agency costs, the race to the bottom, and cognitive biases. Agency costs are the most visible factor. Fee subsidies arose as executives, confronted with civil suits by shareholders alleging that managers were violating their duties to the corporation, sought indemnification for legal fees incurred in countering shareholders' claims.[94] On occasion, executives also sought reimbursement or advancement of fees incurred in defending themselves against criminal charges. Directors of corporations, also interested in being held harmless, often sought to accommodate managers' wishes.[95]

Yet while advancement of legal fees may be necessary in many instances to withstand the welter of civil lawsuits of variable merit, it may not serve the interests of the corporation.[96] Consider a criminal case that leads to conviction of the executive on charges of fraud. While the corporation may be entitled to seek reimbursement from the executive after the conviction becomes final, the executive's assets have often evaporated during the course of the prosecution.[97] Even if the corporation's new management wishes strike a different tone than the one taken by the convicted executive, the fiscal drain involved in the advancement of unrecoverable legal fees to prior managers impedes this process.

The less-than-arm's length dealings between managers, directors, and the corporate entity itself also vitiate exclusions to indemnification that are designed to limit moral hazard.[98] Corporations have often argued - without substantial consultation with shareholders - that executives accused or even convicted of crimes were in fact serving corporate interests.[99] For example, oil company directors were held harmless upon conviction of price fixing.[100] Rather than view the directors' actions as putting the corporation's reputation and assets at risk, the court held that the directors' eventual plea of nolo contendere provided consideration for their indemnification by the corporation.[101] The cozy relationship between corporate directors and managers that produced this accommodation generated agency costs for the shareholders and the public.

Compounding this problem is the effect of moral hazard ex post on the monitoring of legal costs. Reasonableness of legal fees are not a given - they are an exogenous variable from a mysterious realm outside the client's control. Corporate customers for legal services, including carriers in the traditional open market for liability insurance, can exert substantial downward pressure on fees,[102] obliging lawyers to justify their time and avoid the rampant over-billing that pervades the profession.[103] However, since indicted executives frequently do not pay for their own lawyers, they have no incentive to hold down those costs.[104] Members of the corporation's board of directors, similarly spared the burden of paying either the executive's costs or their own, also have no incentive to economize. As noted above, if the executive is convicted, he has neither the inclination nor the ability to pay back the corporation. Because of this interaction of moral hazard and agency costs, the advancement of legal fees strongly resembles secretly granting the executive an option for an unsecured interest-free loan of an indeterminate amount. In this sense, advancement of legal fees is among the more egregious elements in the golden parachute of perks that executives negotiate at less than arm's-length with a supine or self-interested board.[105]

d. D & O Insurance as a Corporate Subsidy

The nature of the financial vehicle for the provision of legal fee subsidies does not materially affect the analysis of D & O insurance as a corporate subsidy. The interaction of moral hazard and agency costs has baleful consequences, whether the advancement of legal fees and indemnification of executives stems from payments made by the corporation itself, or from the workings of D & O insurance. Executives rarely bear the cost of premiums for D & O insurance, which the corporation typically pays for. In this respect, as commentators have long recognized that D & O insurance is less like traditional open-market insurance purchased by the policyholder and more like another element of executive compensation.[106]

D & O insurance also elicits agency costs in other respects. Managers today typically purchase "entity" D & O insurance that covers not only costs incurred by executives, but also costs otherwise borne by the entity, including payments to settle shareholder litigation.[107] Paying premiums for entity-level coverage, however, seems like a bad investment for the corporation, since it could mitigate costs generated by shareholder litigation more inexpensively by instituting effective corporate governance practices.[108] While other areas of insurance, such as property and casualty, involve risks that a corporate customer cannot always predict or control, the corporation's governance is distinctly within the directors' and officers' domain. Controlling for those risks ex ante and "in-house" is by definition cheaper and more efficient than paying premiums to an insurance carrier that reflect the carrier's costs and profits.[109] However, better corporate governance will also limit the agency expenditures that benefit managers.[110] Thus, managers' self-interest gravitates against taking this route.

Corporate managers' preference for entity D & O insurance also stems from concern that significant losses from shareholder litigation draws the attention of stock analysts and regulators, and depresses accounting measures of performance. Each of these factors may in turn adversely affect managers' compensation, or even their tenure with the company.[111] In contrast, the details of D & O insurance often fly under the radar of constituencies that monitor corporate performance. This lack of transparency serves those executives prone to self-dealing. Once D & O insurance is in place, of course, moral hazard kicks in, further discouraging corporate governance controls.

Ex post moral hazard also discourages corporations from controlling legal and other costs that carriers reimburse pursuant to D & O coverage. D & O insurers do not insist that their customers institute ex ante loss prevention measures or control costs ex post, as insurers in other areas like collision insurance do.[112] This may make business sense for the insurer who can charge higher premiums, but it again leaves shareholders holding the bag.

Finally, courts construing ambiguities in D & O policies, particularly on the issue of subsidizing legal fees for defense against criminal charges, typically treat executives seeking subsidies like humble "Mom and Pop" individual policyholders who contracted for collision insurance from giant carriers. As a result, courts usually construe ambiguities in the policy in favor of the insured.[113] This tendency of courts may lead to higher premiums, and here again, managers evade accountability. Indeed, executives seeking expanded coverage get an additional break at the shareholders' expense, since shareholders ultimately pay for the higher premiums, as they do for all payments that dilute corporate earnings.[114]

e. Indemnification, Agency Costs, and the Courts: A Counter-History Erased

Runaway agency costs and moral hazard are not inevitable. In early decisions, courts paid heed to concern about agency costs, often holding that indemnification constituted waste upon waste: subsidizing managers for irresponsible decisions that had already cost shareholders money. On this view, indemnification would exacerbate the problems that a diffuse and disparate group of shareholders face in making managers accountable.[115] By holding that a director assumed the risks of a lawsuit upon accepting the benefits of the director's post, courts responded to moral hazard concerns, reasoning that imposing the risks of misconduct on the bad actor would encourage better decision making.[116] Commentators relied on by courts tended to stress the problems of self-dealing and unaccountable management that indemnification could intensify.[117] Indeed, courts and commentators discussing indemnification during the Great Depression, which many viewed as triggered by corporate excesses, cited problems eerily similar to those recently encountered by corporations such as Enron.[118]

The hopes for a balance of shareholder and management interests regarding indemnification faltered because of another risk to sound corporate governance noted above: the race to the bottom. State legislatures, lobbied heavily by corporate management interests, delivered statutes that insulated management from accountability.[119] These statutes often overruled the cases that limited or barred indemnification.[120] Permitting corporations to indemnify managers in a wide range of contexts, and sometimes mandating indemnification, was part of the strategy that states such as Delaware pursued to make their states attractive to managers.[121] Absent vigorous efforts by government to promote accountability by limiting indemnification, corporations seeking to recruit the most desirable managers engaged in their own race to the bottom, expanding indemnification to cover cases where managers had engaged in egregious self-dealing.[122] In this race to the bottom, shareholder interests often lost out. In the D & O domain, insurance carriers stoked similar fires, arguing in their marketing efforts to corporations that a manager without a D & O policy was a "sitting duck" for litigation by a disgruntled shareholder.[123]

In part, because of these instrumental factors, the cognitive biases reflected in the discourse of indemnification shifted, with some participants arguing that indemnifying the manager for settling cases in advance of trial would actually conserve corporate resources and promote judicial economy.[124] Over time, this view of indemnification as a modern measure to help the corporation "get the best men available" came to dominate discourse by executives, lawyers, and judges.[125] The earlier discourse of waste, rather than appearing a sensible response to excess, began to seem outmoded and formalistic in a litigious age.[126]

For Part II of this article, click here

Professor of Law, Roger Williams University. I thank Dan Richman and Bill Simon for comments on a previous draft.

[1] Joseph W. Bishop, Jr., Sitting Ducks and Decoy Ducks: New Trends in the Indemnification of Corporate Directors and Officers, 77 Yale L.J. 1078 (1968); Pamela H. Bucy, Indemnification of Corporate Executives Who Have Been Convicted of Crimes: An Assessment and Proposal, 24 Ind. L. Rev. 279 (1991); Sean Griffith, Uncovering a Gatekeeper: Why the SEC Should Mandate Disclosure of Details Concerning Directors' and Officers' Liability Insurance Policies, 154 U. Pa. L. Rev. 1147 (2006); Dale A. Oesterle, Limits on a Corporation's Protection of Its Directors and Officers from Personal Liability, 1983 Wis. L. Rev. 513; Stephen A. Radin, "Sinners Who Find Religion": Advancement of Litigation Expenses to Corporate Officials Accused of Wrongdoing, 25 Rev. Litig. 251 (2006).

[2] See Larry D. Thompson, Dep. Atty Gen., United States Dep't of Justice, Principles of Federal Prosecution of Business Organizations (Jan. 20, 2003), (hereinafter Thompson Memorandum). See also A.B.A. Task Force on Attorney-Client Privilege, Report on Employee Rights (August 2006), at n. 36, at [hereinafter ABA Task Force] (citing Phyllis Diamond, SEC Demand for 'Cooperation' Seen Raising Due Process Concerns, 36 Sec. Reg. & L. Rep. 1070 (No. 24; June 14, 2004) (discussing approach to cooperation taken by United States Securities and Exchange Commission (SEC) in enforcement action against Lucent Technologies for faulty accounting)).

[3] See ABA Task Force, supra note 2. The Senate Judiciary Committee has also held hearings on the issue. See Written Testimony of Andrew Weissman, The Thompson Memorandum's Effect on the Right to Counsel in Corporate Investigations, United States Sen. Comm. on the Judiciary, Sept. 12, 2006,, at 3-4 (reporting testimony of partner at major law firm who formerly served as federal prosecutor that Thompson Memorandum abridged right to counsel and right to remain silent).

[4] See United States v. Stein (Stein III), 435 F. Supp. 2d 330 (S.D.N.Y. 2006). See also United States v. Stein (Stein I), 2005 U.S. Dist. Lexis 27812 (S.D.N.Y. Nov. 14, 2005) (denying defendant's bail request); United States v. Stein (Stein II), 410 F. Supp. 2d 316 (S.D.N.Y. 2006) (denying government's motion to disqualify defense counsel); United States v. Stein (Stein IV), S1 05 Crim. 0888 (LAK), 2006 U.S. Dist. Lexis 49435 (S.D.N.Y. July 20, 2006) (suppressing as involuntary statements made by two defendants); United States v. Stein (Stein V), S1 05 Crim. 0888 (LAK), 2006 U.S. Dist. Lexis 63445 (S.D.N.Y. Sept. 6, 2006) (holding that the court had ancillary jurisdiction over defendants' claims for advancement of fees and denied company's motion to dismiss individual defendants' implied contract claims)

[5] See Lucian Bebchuk & Jesse Fried, Pay Without Performance: The Unfulfilled Promise Of Executive Compensation (2004).

[6] See United States v. Locascio, 6 F.3d 924, 931-34 (2d Cir. 1994) (discussing conflicts created when criminal organization subsidizes attorney's fees of its associates).

[7] Many corporations and other business entities conduct their business with care, consider shareholder and customer needs, and encourage dialogue within the company and through outside legal counsel about potential trouble spots. Cf. Stephen M. Bainbridge, Executive Compensation: Who Decides? (Review Essay), 83 Tex. L. Rev. 1615, 1638-39 (2005) (arguing that recent reforms have addressed problems of executive misconduct, and that critics lack empirical basis for arguing that misconduct is pervasive). But see William H. Simon, Introduction: The Post-Enron Identity Crisis of the Business Lawyer, 74 Fordham L. Rev. 947, 948-49 (2005) (arguing that lawyers advising corporations still experience ambivalence about whether loyalty lies with managers or with the business entity, and that this ambivalence injures entity's interests). This article focuses on corporations in which the absence of such values and procedures has caused demonstrable harm to shareholders and to the public.

[8] See Adolf Berle & Gardiner Means, The Modern Corporation And Private Property 128-40 (rev. ed. 1968) (discussing problems caused by separation of ownership and control in modern firms); Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure, 3 J. Fin. Econ. 305 (1976); Lucian Arye Bebchuk & Christine Jolls, Managerial Diversion and Shareholder Wealth, 15 J.L. Econ. & Org. 487, 487-88 (1999); William H. Simon, After Confidentiality: Rethinking the Professional Responsibilities of the Business Lawyer, 74 Fordham L. Rev. (forthcoming 2006), available at (last visited November 19, 2006). Cf. George C. Triantis, Organizations as Internal Capital Markets: The Legal Boundaries of Firms, Collateral, and Trusts in Commercial and Charitable Enterprises, 117 Harv. L. Rev. 1102, 1116 (2004) ("[R]ealistically, managers are self-interested and seek to maximize their private benefits").

[9] See Floyd Norris, Options Brought Riches and Now Big Trouble, N.Y. Times, July 25, 2006, at C1 (discussing technology company Brocade Communications, which recently concluded that it had overstated its profit by over $1 billion because of accounting problems linked to backdated options allegedly approved by its former chief executive).

[10] The article frequently uses the term "subsidy" to refer to advancement of legal fees, to highlight advancement's status as a component of executive compensation,and the low probability that an executive will repay the corporation. See Bishop, supra note 1, at 1090-91; Bucy, supra note 1, at 316 (noting that "it is questionable how aggressively corporations… seek repayment… especially… given the secrecy in which the advances were likely made and the friendly relationship that may exist between the convicted executive and his corporate colleagues who must seek repayment").

[11] Executives unreasonably subjected to personal risks as a result of decisions made in their managerial capacity may also be unduly risk averse, thus imposing agency costs of a different kind. See Bainbridge, supra note 7, at 1620-21. By continuing to allow advancement, insurance, and indemnification in the vast majority of cases, while limiting them in criminal proceedings, the approach taken here accommodates these legitimate concerns.

[12] See Tom Baker & Sean Griffith, The Missing Monitor in Corporate Governance: The Directors' and Officers' Liability Insurer, at 27-30 (paper presented at Law & Society Ass'n Annual Meeting in Baltimore, Md., July, 2006; manuscript on file with the author).

[13] Cf. John C. Coffee, Jr., The Modern Market for Corporate Charters: Competition, Collusion, and the Future, 25 Del. J. Corp. L. 79, 87, 88, 90 (2000) [hereinafter Competition & Collusion] (arguing that scholars have overstated state competition for corporate business, and that groups such as the ABA Corporate Law Section have actually promoted uniformity). See also Joan McLeod Heminway, Rock, Paper, Scissors: Choosing the Right Vehicle for Federal Corporate Governance Initiatives, 10 Fordham J. Corp. & Fin. L. 225, 315 (2005) (discussing business groups' influence in Congress),

[14] See Donald C. Langevoort, Organized Illusions: A Behavioral Theory of Why Corporations Mislead Stock Market Investors (and Cause Other Social Harms), in Behavioral Law And Economics 144, 146-53 (Cass R. Sunstein ed. 2000) (discussing cognitive biases in corporate context); John C. Coffee, Jr., "No Soul to Damn: No Body to Kick": An Unscandalized Inquiry into the Problem of Corporate Punishment, 79 Mich. L. Rev. 386, 396-97 (1992) (discussing dynamics of organizational psychology that can encourage crime at middle management level). Cf. Amos Tversky & Daniel Kahneman, Extensional versus Intuitive Reasoning: The Conjunction Fallacy in Probability Judgment, in Heuristics And Biases: The Psychology Of Iintuitive Judgment 19, 20-21 (Thomas Gilovich, Dale Griffin & Daniel Kahneman eds. 2002) (discussing human beings' dependence on schemas and short-hand strategies in place of careful analysis of evidence).

[15] Milton C. Regan, Jr., Ethics in Corporate Representation: Teaching Enron, 74 Fordham L. Rev. 1139, 1146-47 (2005) (traders who dominated Enron culture "began to 'divid[e] the world into those who 'got it' and those who didn't").

[16] Cf. Griffith, supra note 1, at 1168-72 (offering agency cost rationale for D & O insurance); Baker & Griffith, supra note 12 (acknowledging that "habit" may play a role in decisions to buy D & O insurance, since this decision often lacks clear economic justification).

[17] See infra notes 93-105 and accompanying text.

[18] See John C. Coffee, Jr., Gatekeepers: The Professions And Corporate Governance 205-6 (2006) (arguing that SEC reforms introduced in the 1980's with the commendable goal of increasing efficiency in the issuance of new securities also adversely affected lawyers' due diligence); John C. Coffee, Jr., The Attorney as Gatekeeper: An Agenda for the SEC, 103 Colum. L. Rev. 1293, 1305-11 (2003); Roger C. Cramton, Enron and the Corporate Lawyer: A Primer on Legal and Ethical Issues, 58 Bus. Law. 143 (2002); Regan, supra note 15. After scandals break, politicians newly eager to wear the reformer's mantle may enact solutions that overregulate in certain areas, while failing to address core problems. Cf. Michael A. Perino, Some Reflections on the Deterrence Aspects of the Sarbanes-Oxley Act of 2002, 76 St. John's L. Rev. 671, 676-89 (2002) (expressing skepticism about deterrence value of Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745).

[19] See Griffith, supra note 1; Baker & Griffith, supra note 12.

[20] See N.Y. Dock Co. v. McCollum, 16 N.Y.S.2d 844, 848-49 (N.Y. Sup. Ct. 1939), (citing Griesse v. Lang, 175 N.E. 222 (Oh. 1931)).

[21] See William O. Douglas, Directors Who Do Not Direct, 47 Harv. L. Rev. 1305, 1327 (1934). Cf. Berle & Means, supra note 8, at 203 n. 11 (noting persistent plaint that "to require diligence of directors would prevent 'gentlemen of property and means' from accepting directorships," and responding that "if gentlemen of property and means did not propose to run the business with care they were not acceptable directors").

[22] See N.Y. Dock Co., 16 N.Y.S.2d at 848-49 (N.Y. Sup. Ct. 1939).

[23] See Bishop, supra note 1; Griffith, supra note 1; Radin, supra note 1.

[24] See Thompson Memorandum, supra note 2.

[25] Id. at 4.

[26] Id.

[27] Id. at 5. To ensure that the corporation is not withholding crucial information, prosecutors may ask the corporation to waive attorney-client privilege. Id.

[28] Id.

[29] Id.

[30] United States v. Stein (Stein III), 435 F. Supp. 2d 330 (S.D.N.Y. 2006).

[31] United States v. Stein (Stein IV), S1 05 Crim. 0888 (LAK), 2006 U.S. Dist. Lexis 49435 (S.D.N.Y. July 20, 2006).

[32] See infra notes 173-184 and accompanying text.

[33] See infra notes 208-232 and accompanying text.

[34] See United States v. Solomon, 509 F.2d 863, 869 (2d Cir. 1975).

[35] See Erie Ry. v. Tompkins, 340 U.S. 64 (1938) (requiring that federal courts defer to state law in diversity cases). Brandeis' landmark opinion in Erie resonates with more recent commentators who have recommended that federal courts calibrate their role to promote experimentation in governance. See Michael C. Dorf, The Limits of Socratic Deliberation, 112 Harv. L. Rev. 4, 60 (1998) (citing Erie, 340 U.S. at 64.); Michael C. Dorf & Charles F. Sabel, A Constitution of Democratic Experimentalism, 98 Colum. L. Rev. 267 (1998). Cf. Charles F. Sabel & William H. Simon, Destabilization Rights: How Public Law Litigation Succeeds, 117 Harv. L. Rev. 1015, 1029-33 (2004) (urging use of judicial remedies that promote innovation in public services and benefits).

[36] See Bainbridge, supra note 7.

[37] Cf. Lawrence E. Mitchell, A Theretical and Practical Framework for Enforcing Corporate Constituency Statutes, 70 Tex. L. Rev. 579, 64-43 (1992) (arguing that corporations should be accountable to stakeholders such as employees); Liam Seamus O'Melinn, Neither Contract Nor Concession: The Public Personality of the Corporation, 74 Geo. Wash. L. Rev. 201, 216-20 (2006) (discussing emergence of American corporate law from law of religious and other nonprofit institutions); Susan J. Stabile, A Catholic Vision of the Corporation, 4 Seattle J. Soc. Just. 181, 191-92 (2005) (discussing relationship between welfare of corporation and common good).

[38] On collective action problems, see Sabel & Simon, supra note 35, at 1065 (describing collective action problems as situations, such as the well-known "prisoner's dilemma" game, in which individuals pursue their self-interest to the detriment of the community, because existing institutions do not effectively tailor individual incentives to community needs). On flaws in human and social cognition, see sources cited infra note 53. See David Luban, Making Sense of Moral Meltdowns, in Lawyers' Ethics and the Pursuit of Justice 355, 369 (Susan D. Carle, ed., 2005).

[39] See Regan, supra note 15 , at 1216; William H. Simon, Wrongs of Ignorance and Ambiguity: Lawyer Responsibility for Collective Misconduct, 22 Yale J. on Reg. 1, 12-15 (2005).

[40] See Triantis, supra note 8.

[41] Id. at 1142-43 (arguing that SPE's may enhance investors' ability to monitor business activity, as long as corporation follows rules, including separation of SPE from corporate entity). Cf. Steven L. Schwarcz, The Limits of Lawyering: Legal Opinions in Structured Finance, 84 Tex. L. Rev. 1, 29 (2005) (noting that structured financial transactions, such as the creation of SPE's, are not per se illegal or contrary to shareholders' interests).

[42] See Regan, supra note 15, at 1220-21.

[43] Id. at 1223-24. Cf. William W. Bratton, Does Corporate Law Protect the Interests of Shareholders and Other Stakeholders?: Enron and the Dark Side of Shareholder Value, 76 Tul. L. Rev. 1275, 1309-10 (2002) (discussing Fastow's dealings).

[44] See Regan, supra note 15, at 1222. A legal obligation to disclose significant transactions between a company and senior management promotes transparency and deters self-dealing. Cf. id. at 1220-21 (discussing Fastow's case).

[45] See Berle & Means, supra note 8; Jensen & Meckling, supra note 8; Bebchuk & Jolls, supra note 8; Simon, After Confidentiality, supra note 8.

[46] A range of doctrines, including the corporate opportunity doctrine that holds that corporate officers or other fiduciaries must disgorge to the corporation the fruits of deals they struck on their own behalf that fairly should have been executed on behalf of the corporation, enforce this venerable rule. Cf. Colleen P. Murphy, Misclassifying Monetary Restitution, 55 SMU L. Rev. 1577, 1603-04 (2002) (discussing remedies).

[47] See Regan, supra note 15, at 1230,

[48] But see M. Todd Henderson & James C. Spindler, Corporate Heroin: A Defense of Perks, Executive Loans, and Conspicuous Consumption, 93 Geo. L.J. 1835, 1852-57 (2005) (arguing that executive perks such as private jets, by making the executive more dependent on continued corporate largesse, may reduce agency costs, at least during "final period" prior to executive's retirement).

[49] Cf. Jonathan Macey, Occupation Code 541110: Lawyers, Self-Regulation, and the Idea of a Profession, 74 Fordham L. Rev. 1079, 1085-86 (2005) (arguing that pressure of lawyers' competition with other professions such as accounting reduces effectiveness of self-regulation).

[50] See Coffee, Corporate Punishment, supra note 14, at 399.

[51] A comparable phenomenon occurred in the marketing of tax shelters starting in the 1990's. The organized bar expressed concern about unduly aggressive interpretations of applicable law that skirted the edges of tax fraud, and indeed arguably crossed the line. As a result, accounting firms with fewer scruples stepped in to fill the void. See Tanina Rostain, Sheltering Lawyers: The Organized Tax Bar and the Tax Shelter Industry, 23 Yale J. On Reg. 77, 84-92 (2006).

[52] Cf. Bebchuk & Fried, supra note 5, at 110 (noting absence of link between executives' lucrative retirement packages and job performance); Tom Baker, On the Genealogy of Moral Hazard, 75 Tex. L. Rev. 237 (1996) (discussing theory of moral hazard in insurance). Cf. Kenneth Arrow, Uncertainty and the Welfare Economics of Medical Care, 53 Am. Econ. Rev. 941, 961 (1963) (arguing that in provision of health care, like other market goods, availability of insurance may discourage consumer from finding most efficient provider); Steven Shavell, On Moral Hazard and Insurance, 93 Q. J. Econ. 541 (1979) (discussing incentive effects).

[53] See Christine Jolls, Cass R. Sunstein & Richard H. Thaler, A Behavioral Approach to Law and Economics, in Behavioral Law And Economics 13, 46 (Cass R. Sunstein ed. 2000) (discussing individuals' proclivity for discounting future costs); David Laibson, Golden Eggs and Hyperbolic Discounting, 112 Q. J. Econ. 443 (May, 1997) (arguing that individuals use "commitment mechanisms" such as insurance policies to remedy tendency to discount future costs); Terry O'Donoghue & Matthew Rabin, Doing It Now or Later, 89 Am. Econ. Rev. 103 (March, 1999) (analyzing "present-biased preferences"); Manuel A. Utset, A Model of Time-Inconsistent Misconduct: The Case of Lawyer Misconduct, 74 Fordham L. Rev. 1319, 1324 (2005) (same). See also Sung Hui Kim, The Banality of Fraud: Re-Situating the Inside Counsel as Gatekeeper, 74 Fordham L. Rev. 983, 1030 (2005) (discussing patterns of cognitive bias, which often involve intuitive judgments based on "available beliefs"); Lawrence M. Solan, Cognitive Foundations of the Impulse to Blame, 68 Brook. L. Rev. 1003, 1007-09 (2003) (discussing power of "cognitive scenarios" influenced by intuitions from everyday environments). Cf. Langevoort, Organized Illusions, supra note 14; Donald C. Langevoort, The Epistemology of Corporate-Securities Lawyering: Beliefs, Biases, and Organizational Behavior, 63 Brook. L. Rev. 629 (1997) (discussing power of cognitive frames for interpreting events and reaching judgments).

[54] See Regan, supra note 15, at 1146-47.

[55] See Daryll K. Brown, The Problematic and Faintly Promising Dynamics of Corporate Crime Enforcement, 1 Ohio St. J. Crim. L. 521 (2004) [hereinafter Corporate Crime Enforcement] (arguing that criminal law is underenforced in corporate arena, compared with level of enforcement directed at street crime).

[56] 15 U.S.C. §. 78u-4 (2005).

[57] See Coffee, supra note 18, at 153-55.

[58] See Stephen Labaton, Now Who, Exactly, Got Us Into This?, N.Y. Times, Feb. 3, 2002, sec.3, pa. 1 (noting that three House and Senate committee chairs who supported bill ranked among the largest recipients of campaign contributions from accounting groups).

[59] Coffee, supra note 18, at 155.

[60] See Central Bank of Denver, N.A. v. First Interstate Bank, N.A., 511 U.S. 164 (1994).

[61] See Coffee, supra note 18, at 155-56.

[62] See William J. Stuntz, The Pathological Politics of Criminal Law, 100 Mich. L. Rev. 505 (2001) (discussing convergence of interests between legislators and prosecutors on measures targeting street crime). See also Daniel C. Richman, Federal Criminal Law, Congressional Delegation, and Enforcement Discretion, 46 UCLA L. Rev. 757 (1999) (noting expansion of prosecutorial power prompted by expanding scope of federal criminal law). See generally Jonathan Simon, Megan's Law: Crime and Democracy in Late Modern America, 25 Law & Soc. Inquiry 1111 (2000) (discussing how law enforcement agenda, which author refers to as "governing through crime," marginalizes alternative policy choices).

[63] See Marc Galanter, Planet of the APs: Reflections on the Scale of Law and its Users, 53 Buff. L. Rev. 1369, 1387-88 (2006) (discussing advantages reaped by corporations ("artificial persons" or "APs") as repeat players able to exert influence and cultivate good will within institutions of government).

[64] See Coffee, supra note 18, at 205.

[65] Cf. Robert A. Prentice, The Inevitability of a Strong SEC, 91 Cornell L. Rev. 775, 807-11 (2006) (discussing inadequacy of voluntary disclosure by businesses).

[66] I discuss the legal doctrine underlying prosecution of corporations in greater detail in Part III, infra.

[67] See United States v. Socony-Vacuum Co., 310 U.S. 150 (1940). Cf. Spencer Webber Waller, Thurman Arnold: A Biography 96-98 (2005) (discussing Justice Douglas' Socony-Vacuum opinion from the standpoint of New Dealer and legal theorist Thurman Arnold, who brought the case as head of the Justice Department's Antitrust Division).

[68] See Robert Granfield, In Defense of Tort Law Regulating Corporate Misconduct: The Social Function of Tort Law, 35 Suffolk L. Rev. 491, 506 (2001) (book review) (quoting prosecutor as attributing Ford's acquittal to "enormous legal resources available to the corporation," and noting that "corporate offenders infrequently receive criminal sanctions"). Cf. Carl T. Bogus, Why Lawsuits Are Good For America 190-91 (2001) (documenting Ford executives' knowledge that Pinto's gas tank ruptured in collisions over 25 miles per hour, and their rejection of curative measures that would have cost between $4.20 and $8.00 per car).

[69] See Michael A. Simons, Vicarious Snitching: Crime, Cooperation, and "Good Corporate Citizenship", 76 St. John's L. Rev. 979, 1010-16 (2002).

[70] See Brief of Sec. Indus. Ass'n, et al. as Amici Curiae, United States v. Stein, S1 05 Crim. 888 (LAK) (submitted May 3, 2006) (manuscript on file with the author), at 6, (citing Ken Brown, et al., Called to Account: Indictment of Andersen in Shredding Case Puts Its Future in Question, Wall St. J., March 15, 2002, at A1 (asserting that "no major financial-services firm has ever survived a criminal indictment")). See also Dale A. Oesterle, Early Observations on the Prosecution of the Business Scandals of 2002-03: On Sideshow Prosecutions, Spitzer's Clash with Donaldson Over Turf, the Choice of Civil or Criminal Actions, and the Tough Tactic of Coerced Cooperation, 1 Oh. St. J. Crim. L. 443, 473-76 (2004) (discussing leverage of prosecutors in corporate cases).

[71] See Simons, Corporate Citizenship, supra note 69, at 1001-08, 1010 (contrasting fate of Arthur Andersen, which refused to change management, with survival of Salomon Brothers, which changed management under pressure from its largest shareholder, Warren Buffet and thereby avoided indictment; management changes also resulted in the survival of financial giants Kidder Peabody and Prudential Securities). In cases such as Arthur Andersen, the company may have failed even without an indictment. Andersen long acted as a chief enabler of the questionable financial transactions that allowed Enron to deceive investors, including the accelerated booking of profits on deals where profits were speculative. See Regan, supra note 15, at 1153. The dissemination of information about the Andersen auditors' lassitude, as well as the well-founded concern that regulators would take an especially close look at any future auditing done by the firm, would surely have engendered a strong market reaction. In at least one other prominent case, Martha Stewart, perhaps the corporate executive most closely identified with her company, was indicted, yet her company survived. The company's stock fell, but again this seems like an appropriate reaction to revelations about misconduct by a corporate executive closely linked with the firm in a business space, like financial services, where consumer good will is vital.

[72] This is particularly glaring on issues of compensation. See Bebchuk & Fried, supra note 5, at 27-28 (discussing intertwined financial relationships between managers and board members, including but not limited to perquisites and monetary benefits received by board members at Enron, WorldCom, and Tyco).

[73] See Coffee, supra note 18, at 202-16; Robert W. Gordon, A New Role for Lawyers?: The Corporate Counselor After Enron, in Lawyers' Ethics and the Pursuit of Social Justice 371 (Susan D. Carle ed., 2005); Luban, supra note 38; Deborah DeMott, The Discrete Roles of General Counsel, 74 Fordham L. Rev. 955, 977-79 (2005); Regan, supra note 15, at 1162-66. For arguments that the legal profession has declined in independence and judgment, see Anthony T. Kronman, The Lost Lawyer: Failing Ideals of the Legal Profession (1993) (criticizing the decline of the "lawyer-statesman" and the increasing commercialization and politicization of the profession); Deborah Rhode, In the Interests of Justice: Reforming the Legal Profession (2000) (critiquing profession's thin commitment to serving the public interest); Jean Stefancic & Richard Delgado, How Lawyers Lose Their Way: A Profession Fails Its Creative Minds 52-54 (2005) (describing deadening routine and job dissatisfaction within legal profession); Peter Margulies, Progressive Lawyering and Lost Traditions, 73 Tex. L. Rev. 1139 (1995) (review essay) (asserting that accounts of profession's decline pay insufficient attention to countervailing trends, such as the work of civil rights lawyers and the heightened inclusiveness of the profession); Peter Margulies, Lawyers' Independence and Collective Illegality in Government and Corporate Misconduct, Terrorism, and Organized Crime, 59 Rutgers L. Rev. (forthcoming 2006) (discussing appropriate balance between lawyer's client-centered and gatekeeping responsibilities).

This failure on the part of the legal profession is not confined to the corporate arena. See Margulies, Lawyers' Independence, supra note 73 (discussing ethical failures of Justice Department lawyers who drafted the so-called "torture memos" authorizing apparent violations of federal statutes and international norms); W. Bradley Wendel, Legal Ethics and the Separation of Law and Morals, 91 Cornell L. Rev. 67, 80-85 (2005) (same). The accounting profession has fared no better at constraining abuses. See Coffee, supra note 18, at 27-30 (documenting Arthur Andersen's role in Enron collapse).

[74] See Model Rules of Prof'l Conduct, R. 1.6(b)(2) (2005). Cf. id., R. 1.13(b), (c) (providing that lawyer must inform highest authority within organization of illegal activity that could injure organization; if highest authority fails to act, lawyer may reveal information necessary to prevent substantial harm to organization); section 307 of the Sarbanes-Oxley Act of 2002 (SOX), Pub. L. No. 107-204, 116 Stat. 745 (directing SEC to promulgate regulations setting standards for attorneys practicing before the SEC); 17 C.F.R. § 205.3(d) (2003) (permitting lawyer to reveal information to the SEC to prevent or rectify substantial harm flowing from illegal act by issuer of securities). Cf. Robert Eli Rosen, Resistances to Reforming Corporate Governance: The Diffusion of QLCCs, 74 Fordham L. Rev. 1251 (2005) (discussing reasons why corporations have been reluctant to form Qualified Legal Compliance Committees, pursuant to SEC regulation promulgated under SOX, 17 C.F.R. §. 205.2(k) (2005), that offer safe harbor to attorneys upon institution of internal corporate controls). But see Jill E. Fisch & Caroline M. Gentile, The Qualified Legal Compliance Committee: Using the Attorney Conduct Rules to Restructure the Board of Directors, 53 Duke L.J. 517, 549 (2003) (arguing that SOX provisions encourage too much reporting and result in misallocation of directors' time and effort).

[75] See Model Rules of Prof'l Conduct, R. 1.2(d), 4.1(b) (2005) (stating that lawyer has duty to refrain from aiding or counseling client to engage in illegal conduct, and has obligation to make disclosures necessary to avoid assisting in a material misstatement of fact). Cf. In re. Am. Continental Corp./Lincoln Sav. & Loan Sec. Litig., 794 F. Supp. 1424, 1450-52 (D. Ariz. 1992) (finding that law firm could be held liable for failing to withdraw after client persisted in fraud that ultimately cost United States taxpayers billions of dollars). See also Thomas D. Morgan & Ronald D. Rotunda, Professional Responsibility: Cases and Materials 360-75 (9th ed. 2006) (discussing problems of lawyers confronting possibility of client fraud). But see Peter J. Henning, Targeting Legal Advice, 54 Am. U. L. Rev. 669 (2005) (arguing that federal law enforcement officials have undercut lawyers' advisory role by focusing unduly on advice given by lawyers to corporate clients).

[76] See John C. Coffee, Jr., Rescuing the Private Attorney General: Why the Model of the Lawyer as Bounty Hunter is Not Working, 42 Md. L. Rev. 215 (1983); Griffith, supra note 1, at 1156-57 (discussing agency costs in shareholders' class actions). But see Bogus, supra note 68, at 168-69 (arguing that plaintiffs' lawyers played crucial role in bringing to light safety problems with products such as Ford Pinto).

[77] No corporation can entirely eliminate advancement, insurance, and indemnification. Indeed, to do so would create a different set of dangers to shareholders, entailing undue risk aversion on the part of corporate managers. However, corporations and their regulators should fully understand the virtues and drawbacks of advancement and related practices. Uncovering the flaws in assumptions underlying advancement, insurance, and indemnification is a valuable first step in this process.

[78] See Baker & Griffith, supra note 12.

[79] See Samuel R. Gross, Make-Believe: The Rules Excluding Evidence of Character and Liability Insurance, 49 Hastings L.J. 843 (1998).

[80] See Lubbock Co. Hosp. Dist. v. Nat'l Union Fire Ins. Co., 143 F.3d 239, 242 (5th Cir. 1998).

[81] Aviva Abramovsky, The Enterprise Model of Managing Conflicts of Interest in the Tripartite Insurance Defense Relationship, 27 Cardozo L. Rev. 193 (2005).

[82] Lisa Lerman & Philip Schrag, Ethical Problems In the Practice of Law 336-37 (2005) (noting that under accepted principles of legal ethics, insured is the client, although insurer pays the lawyer's bills). Cf. Restatement (Third) Of The Law Governing Lawyers (2000), § 134, cmt. f (noting that "a lawyer designated to defend the insured has a client-lawyer relationship with the insured. The insurer is not, simply by the fact that it designates the lawyer, a client of the lawyer"); Model Rules of Prof'l Conduct, R. 1.8(f) (2005) (discussing limits on lawyer's acceptance of compensation from a third party, including informed consent by client, no interference with lawyer-client relationship, and confidentiality of information related to the representation). See also Model Rules of Prof'l Conduct, R. 1.6 (requiring that lawyer keep confidential from all parties save the client all information related to the representation); John Leubsdorf, Pluralizing the Lawyer-Client Relationship, 77 Cornell L. Rev. 825 (1992) (discussing dilemmas presented by third parties who play role affecting lawyer-client interaction); Geoffrey Hazard, Triangular Lawyer Relationships: An Exploratory Analysis, 1 Geo. J. Legal Ethics 15 (1987) (discussing dilemmas presented by third parties who play role affecting lawyer-client interaction). But see Ellen S. Pryor & Charles Silver, Defense Lawyers' Ethical Responsibilities: Part II - Contested Coverage Cases, 15 Geo. J. Legal Ethics 29, 34 (2001) (arguing that insurance defense lawyer owes duty of loyalty to both insurer and insured).

[83] See Baker, supra note 52; Baker & Griffith, supra note 12, at 4, 27-29 (discussing moral hazard effects in corporate fee advancement, insurance, and indemnification context). See also Scott Baker & Kimberly D. Krawiec, The Economics of Limited Liability: An Empirical Study of New York Law Firms, 2005 U. Ill. L. Rev. 107, 112 (in arguing that partnerships among lawyers serve insurance function by dispersing risk of business downturn among various specialties, authors observe that carriers would not provide insurance against downturns to lawyers because of moral hazard of lawyer sloth; partnerships do not eliminate moral hazard, since some partners can shirk responsibilities, although partners incur less transaction costs than outside carrier in monitoring such behavior).

[84] See Griffith, supra note 1. Cf. George M. Cohen, Legal Malpractice Insurance and Loss Prevention: A Comparative Analysis of Legal Institutions, 4 Conn. Ins. L.J. 305, 326-27 (1997-98) (discussing loss prevention efforts by insurers in the legal malpractice field, such as continuing legal education for lawyers).

[85] Of course, the government offers social insurance under the Sixth Amendment, providing lawyers for criminal defendants who cannot afford counsel. However, the constitutional right to counsel raises fewer moral hazard problems because an indigent individual has less control over the nature and type of services provided than a defendant or third party paying for legal services. Perceptions of control and status also explain why corporate executives defending themselves against securities claims refuse to permit insurance carriers to choose counsel or manage defense costs. See Baker & Griffith, supra note 12, at 41.

[86] See United States v. Locascio, 6 F.3d 924, 931-34 (2d Cir. 1994).

[87] See Peter Margulies, The Virtues and Vices of Solidarity: Regulating the Roles of Lawyers for Clients Accused of Terrorist Activity, 62 Md. L. Rev. 173, 197-99 (2003) (discussing signaling as element of command structure within violent transnational networks). See also Erica Beecher-Monas, Enron, Epistemology, and Accountability: Regulating in the Global Economy, 37 Ind. L. Rev. 141, 170 (2003) (discussing signaling within corporate entities). See generally Eric Posner, Law and Social Norms 19-24 (2000) (discussing dynamics of signaling behavior).

[88] On the complex interaction of legal ethics and advising clients to cooperate with an investigation, see Daniel C. Richman, Cooperating Clients, 56 Ohio St. L.J. 69 (1995) (discussing efforts by lawyers to position themselves in the marketplace with funders of legal representation by cultivating a reputation for declining to represent informers); Simons, Corporate Citizenship, supra note 69, at 992-95 (discussing federal prosecutors' demand that corporations cooperate in order to avoid indictment); Michael A. Simons, Retribution for Rats: Cooperation, Punishment, and Atonement, 56 Vand. L. Rev. 1, 33-42 (2003) (arguing that cooperation may entail remorse and atonement, instead of merely utilitarian calculus); Ian Weinstein, Regulating the Market for Snitches, 47 Buffalo L. Rev. 563, 614 (1999) (discussing interaction of cooperation and sentencing decisions). Cf. Ellen Yaroshefsky, Cooperation with Federal Prosecutors: Experiences of Truth Telling and Embellishment, 68 Fordham L. Rev. 917 (1999) (describing incentives for dishonesty among cooperators).

[89] See also United States v. Schwarz, 283 F.3d 76 (2d Cir. 2002) (ruling that lawyer representing police officer accused of abuse of suspect in custody had conflict of interest when lawyer had received large retainer from police union, which was the defendant in related civil suit alleging a conspiracy among police officers, and criminal defendant's best defense was that another officer had committed the acts alleged). Cf. Margulies, Lawyers' Independence, supra note 73 (discussing problems of professional independence, including difficulty of giving objective advice to client, in cases where lawyer represents individual while receiving money from organization).

[90] 771 F. Supp. 552, 557 (E.D.N.Y. 1991), aff'd sub nom United States v. Locascio, 6 F.3d 924 (2d Cir. 1994).

[91] See Kenneth Mann, Defending White-Collar Crime: A Portrait of Attorneys At Work 178 (1985) (lawyer with small practice who depended on referrals from larger firm recalled pressure to "'play ball with the team'" by advising individual client not to "spill beans" on the company that the big firm represented).

[92] See Caplin & Drysdale, Chartered v. United States, 491 U.S. 617 (1989).

[93] See Oesterle, Limits on a Corporation's Protection, supra note 1, at 556-59.

[94] See Bishop, supra note 1.

[95] Id.

[96] See Griffith, supra note 1, at 1171.

[97] Cf. Bucy, supra note 1, at 319 (describing as "unrealistic" the expectation that an executive will return an advance of legal fees if a final judgment indicates that the executive committed a criminal act that injured the corporation).

[98] See Bebchuk & Fried, supra note 5.

[99] See Bishop, supra note 1, at 1089 (noting that clause in D & O policy that permits indemnification except for cases of "active and deliberate dishonesty committed… with actual dishonest purpose and intent" gives corporation wide latitude to forgive advance even where executive was found guilty of serious criminal offense).

[100] See Simon v. Socony-Vacuum Oil Co., 38 N.Y.S.2d 270 (N.Y. Sup. Ct. 1942), aff'd, 47 N.Y.S.2d 589 (1944).

[101] Id. at 275.

[102] See Cohen, supra note 84.

[103] See, e.g., Lerman & Schrag, supra note 82, at 427 (noting that one senior partner who billed in 18-minutes increments "rounded up" a one-minute telephone call as representing eighteen minutes of time; according to the authors, rounding up may cost clients millions of dollars annually).

[104] See Baker & Griffith, supra note 12, at 21-25. When corporations have a large deductible in their D & O policy, they become more careful about controlling expenditures. See id. at 23 (quoting one insurance executive who compared a case where a corporation spent $75 million in 18 months, and another case where a corporation spent $3.5 million; executive observed that only material difference in cases was that second corporation had a $20 million deductible, and "they were pounding on that law firm in terms of the bill").

[105] See Bebchuk & Fried, supra note 5, at 88-90. Cf. Bainbridge, supra note 7, at 1627-32 (arguing that collusion between boards and managers in setting compensation packages is less pervasive and less dangerous than Bebchuk and Fried claim).

[106] See Griffith, supra note 1, at 171.

[107] Id. at 1168-73.

[108] Id. at 1172.

[109] Id. at 1168-69.

[110] Managers' decisions about distribution of corporate dividends may reflect similar agency costs. See Daniel J. Morrissey, Another Look at the Law of Dividends, 54 U. Kan.L. Rev. 449, 484 (2006) (arguing that managers' practice of stockpiling cash for potential acquisitions instead of paying out larger dividends reflects managerial drive to "build empires for executives, not value for shareholders").

[111] See Griffith, supra note 1, at 1172-73.

[112] See Baker & Griffith, supra note 12, at 29 (D & O insurers "do[] not constrain defense costs in most cases").

[113] See Newby v. Enron Corp., 391 F. Supp. 2d 541, 570 (S.D. Tex. 2005) (citing Texas rule that ambiguity is interpreted in favor of policyholder in upholding claim by Andrew Fastow, former Enron CFO, that Enron's D & O insurance obligated carrier to advance legal fees to Fastow in his defense against criminal charges that he defrauded the corporation). See also Homestore, Inc. v. Tafeen, 888 A.2d 204 (Del. 2005) (upholding executive's right to indemnification from corporation despite conduct that ultimately led to securities fraud conviction, and attempts to shelter assets from potential creditors, including the corporation); Polychron v. Crum & Forster Ins. Co., 916 F.2d 461 (8th Cir. 1990) (construing term "claim" in D & O policy to include criminal indictment). But see Potomac Elec. Power Co. v. Calif. Union Ins. Co., 777 F. Supp. 980, 984 (D.D.C. 1991) (citing public policy as basis for holding that criminal fine does not constitute "damages" within meaning of D & O policy); In re. Kenai Corp., 136 B.R. 59, 63-64 (S.D.N.Y. 1992) (applying New York case law, under which courts are less prone to find ambiguity under policy and construe ambiguity to benefit policyholder, court found for insurer; court also cited prejudice to insurer caused by difficulty of recovering fee subsidies from manager found to have engaged in illegal conduct); In re. Ambassador Ins. Gp., Inc. Litig., 738 F. Supp. 57, 62 (E.D.N.Y. 1990) (citing New York law as conveying skepticism about courts' willingness to find ambiguity that favors policyholder, court notes that in other jurisdictions "ambiguity appears to be a disease to which insurance policies are peculiarly susceptible"). Cf. Radin, supra note 1, at 289-90 (discussing Delaware case law construing advancement provisions in favor of managers, and arguing that corporations should carefully consider the "credit risk" involved in agreeing to subsidize executives' legal fees in criminal cases on the basis of "usecured undertakings" by executives that they will repay the corporation, citing then- Chancellor William Allen's opinion in Advanced Mining Sys., Inc. v. Fricke, 623 A.2d 82, 84 (Del. Ch. 1992)).

[114] Fee subsidies agreed to pursuant to a contract between a departing executive and the corporation reflect even higher agency costs. Consideration for such an agreement is often illusory, at best. Since managers are typically "at will" employees, they do not have an entitlement to a particular job with the corporation. The manager's agreement to leave may be considered consideration, since it can spare the corporation embarrassment and help persuade prosecutors that the corporation is cooperating with an investigation. However, since the corporation has ample discretion to relieve managers of their duties, this consideration seems attenuated. See Bebchuk & Fried, supra note 5, at 88 (observing that since "[a] board has authority to fire a CEO… [t]here appears to be no need to 'bribe' a poorly performing CEO to step down"). Moreover, the manager's agreement to serve as a corporate consultant as part of a severance package is also less-than-robust consideration for the subsidy of legal fees, since the consultancy agreement itself is often merely camouflage for funneling income to the manager who has agreed to leave, without a real expectation that the manager will perform useful work. Id. at 109 ("consulting arrangements provide flat, guaranteed fees for the… executive's 'being available' rather than payment for work actually done, and for a good reason: companies generally make little use of the availability for which they pay generously"). In this setting, agency costs go through the roof. Accordingly, courts should carefully construe such agreements to benefit the corporation's shareholders, not the well-represented executive entering into a less than arm's-length agreement with former colleagues and associates.

[115] See N.Y. Dock Co. v. McCollum, 16 N.Y.S.2d 844, 850 (N.Y. Sup. Ct. 1939), (citing Douglas, supra note 21, at 1327) (noting the predicament of "the small and isolated investor who needs adequate opportunity for protection against the managers or the board").

[116] Id. at 848-49 (citing Griesse v. Lang, 175 N.E. 222 (Oh. 1931)). These early courts nevertheless left the door open for managers to demonstrate that their conduct in a particular case warranted indemnification because it served the interests of the shareholders. See id. at 850-51. The N.Y. Dock court cited the countervailing policy concerns invoked by Douglas, soon to be appointed Chairman of the Securities and Exchange Commission, that managers in a modern corporation also needed protection against frivolous suits, to avoid discouraging worthy individuals from becoming corporate managers. See id. at 850, (citing Douglas, supra note 21, at 1327).

[117] See Gardiner & Means, supra note 8, at 116 (noting that "concentration of economic power separate from ownership has… created economic empires" presided over by "management capable of perpetuating its own position"); Douglas, supra note 21, at 1308-10 (discussing problems documented in an independent shareholders' report on the "Texas Corporation," including loans from the corporation to managers and expensive lobbying of shareholders by management resisting their opponents in a proxy battle). New Dealers like Douglas understood that robust government enforcement was necessary to ensure effective business self-regulation. See Roberta M. Karmel, Realizing the Dream of William O. Douglas - The Securities and Exchange Commission Takes Charge of Corporate Governance, 30 Del. J. Corp. L. 79, 83-84 (2005) (discussing Douglas' philosophy). Cf. Waller, supra note 67, at 66-71 (noting Thurman Arnold's concern, expressed in his 1930's classic, The Folklore of Capitalism, with the lack of accountability and transparency that made business costs passed on to shareholders and consumers a form of private taxation).

[118] See Douglas, supra note 21, at 1306 (citing evidence of "secret loans to officers and directors, undisclosed profit-sharing plans, timely contracts unduly favorable to affiliated interests, dividend policies based on false estimates, manipulations of credit resources and capital structures to the detriment of minority interests…, and trading in securities of the company by virtue of inside information, to mention only a few" abuses perpetrated by management).

[119] Cf. William L. Cary, Federalism and Corporate Law: Reflections Upon Delaware, 83 Yale L.J. 663, 666 (1974) (quoting the Report of the Law Revision Commission of New Jersey in 1968, which asserted that investors seeking protection would have to look to federal law, since "[a]ny attempt to provide such regulations in the public interest through state incorporation acts… would only drive corporations out of the state to more hospitable jurisdictions"). The phenomenon was exhaustively described during the New Deal era by a prominent jurist with roots in Progressive Era reform. See Louis K. Liggett Co. v. Lee, 288 U.S. 517, 541, 558-59 (1933) (Brandeis, J., dissenting) (noting that corporations gravitated to states "where the cost was lowest and the laws least restrictive. The states joined in advertising their wares. The race was one not of diligence but of laxity.") (citations omitted). Some commentators argue that the competitive federalism described by critics of the race to the bottom is actually a "race to the top," in which states compete in a healthy way to offer more value to investors. See Roberta Romano, Empowering Investors: A Market Approach to Securities Regulation, 107 Yale L.J. 2359, 2365-72 (1978).

[120] See Baker v. Health Mgmt. Sys., Inc., 745 N.Y.S.2d 741, 744 (Ct. App. 2002); United States v. Stein (Stein III), 435 F. Supp. 2d 330, 354 n. 103 (S.D.N.Y. 2006).

[121] See Comment, Law for Sale: A Study of the Delaware Corporation Law of 1967, 117 U. Pa. L. Rev. 861, 874-87 (1969) (discussing indemnification provisions in Delaware statute). The drafters of the Delaware law did outreach to interested parties, including publicly traded companies, designed to "publicize the serious effort being made to attract corporations" through the legislation. Id. at 867 (citing comments of Law Revision Commission member David H. Jackman, President of the United States Corporation Company of New York, in Minutes of the Delaware Corporation Law Revision Commission, 4th Meeting, July 14, 1964, at 2).

The race to the bottom dynamic also buttresses the federal interest in environmental regulation. See Solid Waste Agency v. United States Army Corps of Eng'r, 531 U.S. 159, 174, 180 (2001) (Stevens, J., dissenting) (in case construing the scope of federal water pollution legislation, asserting that interstate nature of migratory bird travels, and dependence of the birds on clean water on their route, gave rise to a federal interest frustrated by a "race to the bottom" process in which individual states compete to attract development with least demanding regulatory regime).

[122] See Comment, supra note 121, at 876 (discussing by-laws revision by corporations such as Bethlehem Steel, Firestone, and Texaco).

[123] See Bishop at 1078.

[124] See Comment, supra note 121, at 880 (discussing comments by Willard Scott, Chairman of the American Bar Association Committee on Corporate Laws, who wrote a Model Act regulating corporations). Champions of this perspective do not consider whether the moral hazard created by paying for settlements will encourage more abuses by managers, therefore leading the corporation to pay out more money than it would otherwise. Id. at 880-81.

[125] Id. at 875 (citing comments by Chair of ABA Section on Corporation, Banking, and Business Laws, in Orval Sebring, Symposium: Duties and Liabilities of Corporate Directors, 22 Bus. Law. 29, 124 (1966). The role of the ABA in setting the terms of discourse about best practices in the "modern" corporation may equal or exceed the role played by more starkly instrumental concerns. Cf. Coffee, Competition & Collusion, supra note 13, at 90 (discussing the role in framing discourse about corporate law played by ABA Corporate Law Section).

[126] Cf. Cary, supra note 119, at 664-65 (describing important formative role of ABA, and noting that less restrictive legislation was broadly perceived as necessary for the "'modernization'" of corporate law).

Comparable arguments were made against accountability for management during the New Deal era. See William O. Douglas, The Forces of Disorder: Destructive Forces in Finance, in Democracy and Finance 6, 13-14 (James Allen ed., 1940) (noting that opponents of reform typically argue that mechanisms for accountability are "retarding prosperity, interfering with the American way, and stifling freedom and initiative," while warning that, "[m]ore often than not these are but the protestations of spokesmen for the predatory elements in finance, though they appear in the guise of the profound judgment of practical men of affairs").

However, corporations in most jurisdictions have not shifted completely from the early default rule barring indemnification to a regime that mandates it. Most state statutes are permissive in a range of circumstances, including those where the executive has failed to prevail on the merits; states have evidently felt that nakedly permitting indemnification in all such instances would lead to an epidemic of agency costs. See Bishop, supra note 1. Perhaps for the same reason, corporations have often imposed a variety of conditions on indemnification that executives seek when they lose a lawsuit, often requiring some showing that even if they lost they acted in the best interests of the corporation and lacked the knowledge that their conduct was unlawful. Corporate by-laws typically require some "independent" determination that a manager meets this standard. D & O insurance also plays a role here, usually requiring indemnification by the corporation if statutes and corporate by-laws permit indemnification, and then holding the corporation harmless for that amount. See Griffith, supra note 1.

This procedure can also be rife with agency costs; often "independence" can simply mean hiring an outside law firm, perhaps even one that usually represents the corporation. See Bishop, supra note 1, at 1080. The circumstances of the hiring allow the corporation to signal that it would prefer to indemnify, because of its cozy relationship with the malfeasant manager. A law firm that wishes to secure more business in this realm of "independent" review therefore gets swept up in the race to the bottom, spurring it to approve indemnification in most cases. Id.