In the enforcement and compliance arena, there are instances of misconduct that underscore important governance principles. But this just sounds like a bunch of mumbo jumbo (the technical term, I know).

In the face of inexplicable behavior and failures to act, I often come back to the simple, but powerful phrase, “You Should Have Known Better.”  The use of this phrase carries with it a powerful judgment concerning individual behavior and responsibility.  See Bailey Kuklin, You Should Have Known Better, 48 U. Kan. L. Rev. 545 (2000).  As explained by Bailey Kuklin (pp. 545-46):

[The] more interesting use of the expression suggest[s] that, because the actor should have been aware of the antisocial or illegal consequences of [his/her] act, by choosing to act nevertheless, [he/she] acted reprehensibly in circumstances in which we would not blame others at all, or [he/she] acted more reprehensibly than we would judge others to have acted. [footnote omitted]. . . [T]he actor is not simply blameworthy; [he/she] is more blameworthy because [he/she] should have known better.

This concept of knowledge and culpability came to my mind when reviewing the behavior of the Herbalife corporate board and internal audit function described in the Herbalife FCPA settlement. 

I do not plan to recite the relevant duties applicable to each board member – e.g., duty of care, duty of loyalty.  Nor do I intend to explain the important roles that the the Audit Committee and the Internal Audit function play under Sarbanes-Oxley and corporate governance requirements.

To resolve its FCPA violations, Herbalife entered a three-year deferred prosecution agreement (“DPA”) and agreed to pay the Justice Department $55 million and the SEC $67 million.  Over a ten-year period, Herbalife paid $25 million to Chinese government officials for bribes, hospitality and gifts.

In particular, Herbalife’s China Internal Auditor prepared reports of Herbalife’s External Affairs office detailing large amounts spent on meals, gifts and entertainment. 

For example, in 2012, over a six-month period, the report calculated that the EA office spent $3.7 million for 239 meals involving 4,312 participants averaging $3232 per meal. 

In 2015, the Internal Audit report cited 115 restaurant meals with government officials at an average cost of $1472 per meal.  In addition, the 2015 report cited that EA often replaced problematic receipts and had expended $811,465 without the corporate approvals required.

These reports were presented to Herbalife’s board in Los Angeles by the Internal Auditor.  As explained by the government in its settlement papers, two board members raised concerns about these reports and asked if the amount of these expenditures were “reasonable” under the FCPA.  The Internal Auditor responded that these findings were “typical” and are within “tolerances.”

Herbalife’s board and internal audit functions “should have known better.”  The questions raised by the board members and the response from the Internal Auditor are indefensible.  At a minimum, the reports by themselves required further investigation by the Internal Auditor, legal and compliance to determine the nature and scope of the hospitality expenditures. 

In reviewing these facts, some may infer that the board and the auditor “knew” that bribery was occurring and decided to turn a blind eye.  While that may be true, at a minimum, their collective failure to act supports a reasonable conclusion that they declined to act knowing that further inquiry would uncover significant wrongdoing. 

Under these circumstances, there appears to be a significant question concerning accountability.  Are the two directors still on the Herbalife board?  What happened to the Internal Auditor? 

If accountability means anything, DOJ and the SEC should have investigated the conduct of these officials and determine if there was sufficient evidence to establish civil or criminal liability.  At a minimum, these officials “should have known better” and should not be allowed to escape accountability.