Practical Applications of the Yates Memorandum for the U.S. Food Industry
The following article was written by Andrew Ittleman, Jessika Tuazon and Stephen Wagner for the January/February edition of the Food and Drug Law Institute’s Update Magazine. A full copy of the edition is available here. Fuerst Ittleman David & Joseph is a proud member of FDLI, and the firm’s lawyers frequently lecture and write on compliance and enforcement matters affecting the food, drug, biological product and dietary supplement industries. We repost the article here with FDLI’s permission.
2015 was a landmark year for the United States food industry. Fresh off the heels of finalizing significant food safety regulations in 2014, FDA took an increasingly aggressive approach to regulation and enforcement, including working closely with the Department of Justice (“DOJ”) to pursue prosecutions against companies and individual employees responsible for introducing tainted food into interstate commerce. These efforts resulted in some of the strictest penalties ever seen in adulteration cases.
This trend shows no sign of relenting, especially in light of Deputy Attorney General Sally Quillian Yates’s recent Memorandum directing DOJ personnel to focus on holding individuals accountable in all civil and criminal corporate investigations. Together, the Yates Memorandum and FDA’s recent enforcement priorities will have a substantial effect on the relationships between corporations and their employees, as well as the manner by which corporations govern themselves when faced with government investigations or prosecutions.
In this article, we explore various issues that companies and their executives and employees must address in light of this new regulatory climate. We also suggest measures that should be implemented with the best interests of both the company and its employees in mind.
Regulation and Enforcement of the Food Industry (2014-2015)
Armed with increased enforcement powers under 2011’s Food Safety Modernization Act (“FSMA”) and 2014-2015 rulemaking to finalize applicable regulations, FDA conducted multiple, highly-publicized investigations into contaminated food products. FDA moved swiftly, for example, to investigatelisteria in ice cream products manufactured by Blue Bell Creameries and Jeni’s Splendid Ice Creams resulting in the shutdown of manufacturing activities and recall of ice cream products for both companies.[i] Similarly, FDA conducted highly publicized investigations into cyclosporiasis-tainted cilantro from Puebla, Mexico,[ii] as well as contaminations of tomatoes[iii], soft cheese[iv], cucumbers[v], and various other food products.
FDA also took an increasingly assertive approach to prosecuting individuals for their roles in cases of violative food products. For instance, an investigation into cantaloupes linked to 33 deaths and 147 hospitalizations led to the sentencing of Eric and Ryan Jensen, the owners of the cantaloupe farm, to serve five years of probation, complete 100 hours of community service, and pay $150,000 in restitution. Likewise in 2015, Austin DeCoster and Peter Decoster of Quality Egg LLC pleaded guilty to one count of introducing salmonella-tainted eggs into interstate commerce and were sentenced to serve three-month prison terms followed by one year of supervised release and pay a $100,000 fine.[vi] Finally, on September 21, 2015, Peanut Corporation of America (“PCA”) executives and employees Stewart Parnell, Michael Parnell, and Mary Wilkerson were sentenced to terms of 28, 20, and 5 years in prison, respectively, for their individual roles in PCA’s introduction of salmonella-tainted peanuts into interstate commerce.[vii] Mr. Parnell’s 28-year prison sentence is regarded as the toughest penalty ever given for a corporate official in a food poisoning outbreak.
The PCA, Quality Egg, and Jensen cases stand in stark contrast to the old-form Odwalla and Sara Lee cases, in which both companies pled solely to misdemeanor FDCA violations even though they were responsible for killing and sickening dozens of people. However, given Congress’s new focus on the U.S. food supply and FDA’s apparent attention to its Congressional mandate, we expect the Government’s recent focus on individuals to be the new norm. This is especially true given a recent, dramatic change in DOJ policy.
New Focus on Individuals in Civil and Criminal Corporate Investigations
On September 9, 2015, Deputy Attorney General Yates issued a Memorandum to DOJ staff[viii] outlining changes to DOJ policies in corporate criminal investigations. The Yates Memorandum directs the government in all ongoing and future civil and criminal corporate investigations to “focus on individual wrongdoing from the very beginning of any investigation of corporate misconduct” because it will increase the likelihood of cooperation and will “maximize the chances that the final resolution of an investigation…will include civil or criminal charges against not just the corporation but against culpable individuals as well.”[ix]
In order to bring about this sea change in Justice Department policy, the Memorandum sets forth “six key steps” applicable to all investigations of corporate wrongdoing:
- To be eligible for any cooperation credit, corporations must provide to the DOJ all relevant facts about the individuals involved in corporate misconduct.
- Both criminal and civil corporate investigations should focus on individuals from the inception of the investigation.
- Criminal and civil attorneys handling corporate investigations should be in routine communication with one another.
- Absent extraordinary circumstances, no corporate resolution will provide protection from criminal or civil liability for any individuals.
- Corporate cases should not be resolved without a clear plan to resolve related individual cases before the statute of limitation expires and declinations as to individuals in such cases must be memorialized.
- Civil Attorneys should consistently focus on individuals as well as the company and evaluate whether to bring suit against an individual based on considerations beyond the individual’s ability to pay.
The Yates Memorandum[x] represents a major expansion of DOJ’s enforcement focus, especially to the extent that it raises the bar for “cooperation credit.” The Memorandum makes clear that “to be eligible for any credit for cooperation, the company must identify all individuals involved in or responsible for the misconduct at issue, regardless of their positions, status or seniority, and provide to the Department all facts relating to that misconduct.”[xi] Under this framework, companies will be under increased pressure to disclose information about individuals linked to corporate misconduct, potentially forcing companies to waive their attorney-client privilege[xii] and make other difficult decisions about what information and whose identities should be disclosed.
More profoundly, the Yates Memorandum makes clear that individuals will now be the primary focus of every government investigation into corporate misconduct, and requires prosecutors to obtain special authorizations in order to avoid charging individuals in cases of corporate wrongdoing: “If a decision is made at the conclusion of the investigation not to bring civil claims or criminal charges against the individuals who committed the misconduct, the reasons for that determination must be memorialized and approved by the United States Attorney or Assistant Attorney General[.]”[xiii] Thus, the Yates Memorandum may fairly be read to create a default rule that individuals will be charged either criminally or civilly in any case in which the company itself faces charges.
As written, the Yates Memorandum immediately impacts every company regulated by the U.S. government. Because companies may have to divulge confidential communications in order to obtain “cooperation credit,” such communications with employees become far more sensitive. Consequently, employees may be more hesitant than ever to participate unrepresented in internal investigations and instead choose to retain their own counsel, thus changing how companies conduct internal investigations. The Yates Memorandum may also influence the demands that individual executives and employees place upon the corporation for protection in advance of, and in the event of, government investigations.
How Companies (and Their Employees) can Protect Themselves in this New Regulatory Environment
Perhaps above all else, the Yates Memorandum calls upon companies to review their governing charters and corporate policies to ensure that they adequately set forth how the company will protect its individual executives and employees in the event of government intervention, including indemnification, advancement, and insurance for the fees and costs related to investigations, prosecutions and, potentially, fines and penalties. Below, we describe issues that companies should be mindful of and changes that they can make in the wake of the Yates Memorandum’s overhaul of Justice Department policy.[xiv]
Indemnification and Advancement
No corporation can be a success unless led by competent and energetic officers and directors. Such individuals would be unwilling to serve if exposed to the broad range of potential liability and legal costs inherent in such service despite the most scrupulous regard for the interests of stockholders. This is the rationale behind the indemnification and advancement provisions of Delaware corporate law.
Delaware Vice Chancellor Sam Glasscock, III
Hermelin v. K-V Pharmaceutical Co.
54 A.3d 1093 (Del. Ch. 2012).
Most companies indemnify their officers and directors for corporate actions in one manner or another; however, far fewer have formal policies in place. Sometimes indemnification and advancement provisions are contained in the certificate of incorporation or the bylaws, while other times they may be found in employment or director services agreements. Still other times such policies are informal or unwritten and merely offered or compelled after an investigation or unsuccessful prosecution. However, it is rare today to find a company that extends such indemnification and advancement protections beyond its officers and directors and down to its average employee.
With the government’s new focus on individuals, a patchwork of non-focused corporate policies made on an ad hoc basis are unlikely to withstand the pressure of a government investigation. On the one hand, the company may be too focused on addressing the compliance flaws that led to the government investigation to be able to address which of their employees should have their attorneys fees advanced and on what terms. On the other, the government could perceive ad hoc decision making in this context as merely “protective” of culpable employees and therefore weigh it against the company when assessing the adequacy of its cooperation.[xv] Therefore, we now describe the steps that companies can take today to solidify their indemnification and advancement policies, and better enable them to respond to government enforcement actions when they arise.
Where to Codify Indemnification and Advancement Policies?
While the corporation statutes of each state set forth certain indemnification and advancement rights and obligations applicable to domestic corporations, these obligations are typically binding only if they are incorporated into the corporation’s organizational documents or other legal instruments, such as employment contracts or policies outlined in at-will employment agreements. Placing such provisions in a company’s governance documents – as opposed to placing them in an individual’s employment agreement – avoids the potential conflicts that can arise if an employee has breached his or her employment contract. Also, many individuals may be at-will employees without any employment agreement at all. Therefore, placing the indemnification and advancement provisions into the corporate Certificate or Bylaws[xvi] will ensure that the safety net is extended under every employee.
How to Draft Indemnification/Advancement Provisions under Delaware Law
First and foremost, companies adopting or amending indemnification and/or advancement provisions in their governance documents must ensure that the provisions are legally sufficient under the corporation laws of the company’s state of organization. The Delaware General Corporation Law, for example, requires that a Delaware corporation’s indemnification and advancement polices have certain features.
One provision that must be in place for all Delaware companies is mandatory indemnification. The statute requires a company to indemnify a present or former director or officer who “has been successful…in defense of any action, suit or proceeding” for “expenses (including attorneys’ fees) actually and reasonably incurred by such person in connection” with a successful defense.[xvii] Delaware law also establishes the standard of conduct that is generally required for indemnification. Under section 145(a) of the statute, a director, officer, or employee will be eligible for indemnification from third-party claims “if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation.”[xviii]
The Delaware statute also sets forth how the company must determine whether the individual has satisfied this standard of conduct.[xix] This determination is the lynchpin of the indemnification/advancement provisions. Without a proper determination of an employee’s conduct, DOJ or the courts could vitiate the indemnification/advancement and leave the employee without his expected safety net. However, with a statutorily defined determination of an employee’s conduct, the company can more soundly provide its employee with the protection needed in the investigation or prosecution. Under Section 145(d) of the Delaware General Corporation Law, the determination of whether the individual has met that standard of conduct shall be made:
(1) by a majority vote of the directors who are not parties to such action, suit or proceeding, even though less than a quorum, or
(2) by a committee of such directors designated by majority vote of such directors, even though less than a quorum, or
(3) if there are no such directors, or if such directors so direct, by independent legal counsel in a written opinion, or
(4) by the stockholders.[xx]
We strongly recommend that only outside directors with independent ethics counsel, or an independent legal counsel make the determination of conduct. Leaving the determination to the board of directors or the shareholders may create an inherent conflict of interest which could defeat the very purpose of the indemnification and advancement provisions.
Finally, if a company chooses to advance legal fees and expenses to its current officers or directors, Delaware law imposes the condition that a company receive “an undertaking by or on behalf of such director or officer to repay such amount if it shall ultimately be determined that he is not entitled to be indemnified by the corporation.”[xxi] While all other forms and procedures of indemnification and/or advancement are permissive under Delaware law[xxii], such as indemnification of fines or monetary penalties, companies must ensure that these minimum statutory requirements are met.
Drafting Indemnification/Advancement Provisions after the Yates Memorandum
Companies updating their governance documents in the wake of the Yates Memorandum must not only ensure the legal adequacy of the indemnification and advancement provisions, but their functional adequacy as well.
For example, while most indemnification provisions have become boilerplate, many do not expressly allow for indemnification and advancementfor costs, expenses, fines, or penalties arising from investigations and prosecutions, yet this is where a company’s commitment to its employees may first be tested. Government investigations of corporate wrongdoing can take years to resolve, and during this time an individual employee may incur legal fees that he or she could never afford without the company’s assistance.
And although Delaware state law does not require companies to provide mandatory advances, companies should nevertheless consider doing so as a company policy. Specifically, Delaware’s Court of Chancery has stated that “[m]andatory advances, like indemnification, serve the salutary purpose of encouraging qualified persons to become or remain as directors of Delaware corporations, by assuring them, ex ante, that they may resist lawsuits that they consider meritless, free of the burden of financing (at least initially) their own legal defense.”[xxiii] In light of the Yates Memorandum, this “encouragement” is now potentially as critical for rank-and-file employees as for officers and directors. Providing for the advancement of defense costs, expenses, and legal fees will not only help to attract high-caliber candidates for employment, but can also help to maintain employees’ trust and confidence in the corporation, thus actually improving the company’s ability to cooperate with government investigations.
That said, companies should also think critically about setting restrictions or conditions on indemnification or advancement. For example, borrowing the mandatory advancement language for officers and directors under Delaware law, companies may want employees to provide “undertakings” that they will repay advancements in the event that they ultimately do not qualify for indemnification. Companies may also provide coverage for civil or criminal fines or penalties but may decline to indemnify individuals who engaged in any gross negligence or willful misconduct giving rise to the action. However, in setting such limitations, companies walk a very fine line. For example, many indemnification provisions prohibit indemnification if an individual has violated any regulatory or statutory requirements, but such language would be devastating for employees of FDA-regulated businesses, as FDCA violations often do not require any proof of knowledge, bad faith or intent. One standard we recommend is taken directly from Delaware law: indemnification and advancement is provided whenever the acts or omissions of the officer, director, or employee are pursuant to company authorization (i.e., in or not opposed to the best interests of the corporation) or undertaken in good faith, with no reasonable cause to believe the person’s conduct was unlawful, regardless of whether the investigation/proceeding was terminated by settlement, judgment, or conviction.[xxiv]
Review and Update Company Insurance Coverage
Corporate insurance policies are also important in a post-Yates enforcement environment because they may mitigate costs related to government investigations. As such, companies must carefully evaluate their insurance portfolio to understand what is (and is not) covered in the event of a government investigation and/or prosecution.
Directors and Officers Liability (“D&O”) insurance policies typically offer liability coverage for company officials when corporate indemnification is not available, whether due to insolvency or legal prohibition. D&O insurance policies may also reimburse companies for indemnifying company officials. Side A coverage typically refers to policies that cover the personal liability of company directors and officers as individuals, where indemnification by the corporation is not legally required. Side B coverage typically refers to coverage for the corporation when it indemnifies directors or officers against third-party claims. While D&O policies may cover defense costs arising out of regulatory investigations or proceedings, as well as certain civil or criminal actions that may be brought against directors or officers of the company, they do not typically cover non-officer or director employees, nor any fines or penalties that result from intentional violations of the law. These deficiencies become more acute in light of the Yates Memorandum.
Due to the increase in potential expenses associated with DOJ investigations, companies should consider the adequacy of their insurance policies and evaluate how they can be updated to provide coverage for the company and individual employees. For example, corporations should consider the following issues:
– Does the company have Side A coverage?
– Which employees are covered under the policy, and what are the limits for coverage?
– How does the policy define a “claim” to trigger the coverage of defense expenses?
– Is the amount of coverage adequate? Is the coverage sufficient if claims are filed for multiple individuals and the company?
– What types of fines or penalties, if any, does the insurance policy cover?
– Does the insurance policy extend over regulatory investigations and proceedings?
– Does the insurance policy cover any liability the company may incur as a result of disclosing information about employees and their role in misconduct under investigation?
– Does the policy contain any conduct exclusions?
– Under what circumstances may the insurance carrier avoid coverage (e.g., the company’s financial state, failure to provide the carrier with information related to a potential claim when the company applied for coverage, etc.)?
– Does the insurance carrier offer supplemental policies to cover increased costs associated with investigations or proceedings involving non-director or officer employees?
Although the full consequences of the Yates Memorandum are not yet evident, companies should nevertheless take this opportunity to carefully review their insurance coverage to provide better protection from increased indemnification and advancements.
Based on FDA’s recent enforcement efforts and DOJ’s new initiative to aggressively “seek accountability from the individuals who perpetrated the wrongdoing[,]”[xxv] individuals working at every level of FDA-regulated companies must recognize that any inquiries into a company’s misconduct effectively exposes them all as potential targets of lengthy investigations or subsequent legal proceedings. In response, regulated companies must thoroughly review their governing documents and insurance policies to ensure they provide adequate protection against the realities of a new enforcement environment.
[i] See FDA, “FDA Investigates Listeria monocytogenes in Ice Cream Products from Blue Bell Creameries,” available at www.fda.gov/Food/RecallsOutbreaksEmergencies/Outbreaks/ucm438104.htm (last accessed: Oct. 29, 2015); FDA, “Jeni’s Splendid Ice Creams Recalls All Products Because of Possible Health Risks,” available at www.fda.gov/Safety/Recalls/ucm444451.htm (last accessed: Oct. 29, 2015).
[ii] FDA Import Alert 24-23, “Detention Without Physical Examination of Fresh Cilantro from the State of Puebla, Mexico,” available at www.accessdata.fda.gov/cms_ia/importalert_1148.html (last accessed Nov. 15, 2015).
[iii] See e.g., FDA’s Team Tomato Fights Contamination, available at www.fda.gov/ForConsumers/ConsumerUpdates/ucm359658.htm (last accessed: Nov. 15, 2015).
[iv] See e.g., FDA Investigated Listeria Outbreak to Soft Cheeses Distributed by Karoun Dairies, Inc., available at www.fda.gov/Food/RecallsOutbreaksEmergencies/Outbreaks/ucm463289.htm (last accessed: Nov. 15, 2015)
[v] See e.g., FDA Investigates Multistate Outbreak of Salmonella Poona Linked to Cucumbers, available at www.fda.gov/Food/RecallsOutbreaksEmergencies/Outbreaks/ucm461317.htm(last accessed: Nov. 20, 2015); Food Safety News, CDC Update: 4 Deaths, 767 Salmonella Cases in 36 States Linked to Cucumbers, available at www.foodsafetynews.com/2015/10/1-death-more-than-300-confirmed-salmonella-cases-in-27-states-linked-to-mexican-cucumbers/#.Vk9KpXarTcs (last accessed: Nov. 6, 2015).
[vi] DOJ, Quality Egg, Company Owner And Top Executive Sentenced In Connection With Distribution Of Adulterated Eggs, available at www.justice.gov/usao-ndia/pr/quality-egg-company-owner-and-top-executive-sentenced-connection-distribution (last accessed: Dec. 3, 2015).
[vii] DOJ, “Former Peanut Company President Receives Largest Criminal Sentence in Food Safety Case; Two Others also Sentenced for Their Roles in Salmonella-Tainted Peanut Product Outbreak,” available at www.justice.gov/opa/pr/former-peanut-company-president-receives-largest-criminal-sentence-food-safety-case-two (last accessed: Oct. 25, 2015).
[viii] Yates Memorandum, Department of Justice, September 9, 2015, available at http://www.justice.gov/dag/file/769036/download.
[ix] Id. at 4.
[x] The U.S. Attorneys’ Manual (“USAM”) was revised to incorporate these policy objectives, including new sections on enforcing claims against individuals in civil cases, guidelines on when to bring a criminal action against individuals, and procedures for increasing criminal and civil cooperation and referrals for parallel proceedings. See DOJ, Deputy Attorney General Sally Quillian Yates Delivers Remarks at American Banking Association and American Bar Association Money Laundering Enforcement Conference Washington, DC, available atwww.justice.gov/opa/speech/deputy-attorney-general-sally-quillian-yates-delivers-remarks-american-banking-0.
[xi] Yates Memorandum at 2 (emphasis added).
[xii] We are reminded by a former federal prosecutor who now serves on FDLI’s esteemed editorial board that the Yates Memo in no way impacts “DOJ’s policy that prohibits the government from even asking – much less forcing – targets to waive attorney-client privilege.” While this is technically true, we note the following two critical points. First, rather than remaining static, at least one United States Court of Appeals has recently described the Justice Department’s position on corporate waivers of the attorney-client privilege as “evolving” through a series of “memoranda by so many Deputy Attorneys General over so many years.” see Feinberg v. IRS, No. 15-1333, 6, n.3 (10th Cir. Dec. 18, 2015). And second, while the Yates Memorandum does not require corporate targets to waive their attorney client privilege in order to obtain cooperation credit, other Justice Department memoranda have explicitly stated that prosecutors may consider a corporation’s waiver of its privileges “both with respect to its internal investigation and with respect to communications between specific officers, directors, and employees and counsel.” See e.g. Memorandum from Larry D. Thompson, Deputy Att’y Gen., U.S. Dep’t of Justice (Jan. 20, 2003).
[xiii] Yates Memorandum at 6.
[xiv] For the purposes of this analysis, we will focus our review on the laws pertaining to companies incorporated under Delaware law. Please keep in mind that depending on the state or jurisdiction in which the company is organized, qualified, or operates, some of these protections may need to be modified to meet the requirements of applicable laws.
[xv] See e.g. Memorandum from Larry D. Thompson, Deputy Att’y Gen., U.S. Dep’t of Justice (Jan. 20, 2003); but see Memorandum from Mark Filip, Deputy Att’y Gen., U.S. Dep’t of Justice (Aug. 28, 2008).
[xvi] If a company must add sufficient indemnification or advancement provisions to its governing documents, the Bylaws may be the preferable place to do so. Generally, under Delaware law, the Certificate of Incorporation can only be amended by the stockholders (8 Del. C. § 242(b)), while most companies’ Bylaws allow for amendment of that document by the board of directors.
[xvii] 8 Del. C. § 145(c).
[xix] 8 Del. C. § 145(d).
[xx] 8 Del. C. § 145(d).
[xxi] Id. Although the undertaking to repay is binding on the person seeking advancement, Delaware law does not require the undertaking to be a secured obligation.
[xxii] See generally, 8 Del. C. §§145(a) and (e).
[xxiii] In re Cent. Banking Sys., 1993 WL 183692, at *3 (Del. Ch. May 11, 1993).
[xxiv] 8 Del. C. § 145(a).
[xxv] Id. at 1.