On Oct. 8, 2019, Assistant Attorney General Brian A. Benczkowski from the Criminal Division of the Department of Justice released a memorandum that contained a number of additional policies and procedures to enhance transparency in cases where questions arise concerning an organization’s ability to pay potential criminal fines or monetary penalties. This memorandum introduced an Inability-to-Pay Questionnaire, new terminology such as “continued viability” and “collateral consequences,” and an updated framework that should be used to measure an organization’s ability to pay any such assessments.
This article provides background on a relevant DOJ enforcement action, explores the concepts examined in the memorandum and discusses the importance of consulting with advisors who have the range of skills and experience necessary to evaluate an entity’s ability to continue future operations in light of potential settlement amounts (i.e., evaluating going concern issues).
Before the issuance of this memo, the U.S. Sentencing Commission Guidelines Manual and the sentencing provisions of U.S. Code Title 18–Crimes and Criminal Procedure, addressed the issue of inability to pay in certain respects but lacked specific guidance on how claims are considered.1 As discussed in section 8C3.2 of the U.S. Sentencing Commission Guidelines, “immediate payment of the fine shall be required unless the court finds that the organization is financially unable to make immediate payment or that such payment would pose an undue burden on the organization.”2
While the intent of the DOJ’s historical guidance was to reduce the risk that an organization will collapse because of imposed fines, corporate bankruptcies do occur as a result of enforcement settlements. These bankruptcies have called into question the effectiveness and sufficiency of the DOJ’s historical process used to analyze an entity’s ability to pay.3
The DOJ’s new guidance clarifies the process and types of information that it will consider in order to accelerate its evaluation of an organization’s ability to pay fines. Specifically, the DOJ states, “a business organization's ability to pay an agreed upon criminal fine or monetary penalty will often be determined by an analysis of its responses to the Inability-to-Pay Questionnaire to determine the company's current assets and liabilities, as well as to compare current and anticipated cash flows against working capital needs."4
As organizations work closely with their legal counsel to identify, quantify and disclose compliance issues to enforcement agencies, they must proactively quantify and evaluate the impact of potential fines and penalties. Organizations should carefully evaluate their ability to pay such fines in conjunction with the DOJ’s recent guidance before the outset of settlement discussions. During these discussions, organizations should be prepared to discuss a number of fundamental concepts surrounding their ability to pay any disgorgement or levied fines.
A proactive approach is necessary given that the memorandum dictates that the burden of establishing an inability to pay rests with the organization making the claim, and the organization must offer complete cooperation to the inquiries of the prosecution. Most notably, this includes a complete and timely response to the Inability-to-Pay Questionnaire, which requests information on the following:
- Cash flow projections
- Operating budgets and projections of future profitability
- Capital budgets and projections of annual capital expenditures
- Proposed changes in financing or capital structure
- Acquisition or divestiture plans
- Restructuring plans
- Claims to insurers
- Related party transactions
- Encumbered assets
- Liens on assets
- Audited financial statements, tax returns and a number of other detailed financial schedules5
Fundamentally, organizations should evaluate their ability to pay based on a range of projections, including future cash flow and working capital needs. Each of these measures is dependent on a range of factors—some of which a company can influence, and others that are dictated by market forces outside of their control.
For example, a primary driver of future cash flows is projected revenues, which are in turn dependent on a range of factors, including pricing power, actions of competitors (both existing and potential entrants), production capacity, demand, access to capital and product life cycles, just to name a few. Each of these inputs must be evaluated and incorporated into the financial modeling process. Given the complexity and variability involved in modeling future performance, conducting an in-depth analysis of the relevant inputs is critical to producing a reliable and defensible assessment.
The DOJ’s recent guidance combines a number of important considerations, including:
- The going concern concept established by the Financial Accounting Standards Board,6 which requires the application of judgment from experienced certified public accountants (CPAs)
- Any negative consequences to stakeholders resulting from financial accommodations made by an organization to make full and prompt payment of a fine or penalty
Given the complexity in evaluating going concern in the context of current FASB standards, the DOJ has provided a bifurcated evaluation framework that relies on new terminology as follows:
- Continued viability: Criminal fines and penalties “threatening the continued viability of the organization.” Criminal Division attorneys should consider whether the organization has addressed going concern issues with its outside auditor prior to asserting an inability-to-pay claim. In doing so, Criminal Division attorneys “may find it helpful to consult” the going concern accounting standards. These standards include items to consider such as principal conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern, as well as management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations and their plans that alleviated substantial doubt about the entity’s ability to continue as a going concern.7
- Collateral consequences: Criminal fines and penalties “impairing the organization's ability to make restitution to victims.” Consistent with the principles of the memorandum, “Criminal Division attorneys may, where appropriate, make an adjustment to a proposed criminal fine or monetary penalty based on the existence of a significant adverse collateral consequence that, while severe, may not necessarily threaten the continued viability of the organization. In such cases, the adjustment to the monetary penalty amount should not be more than necessary to avoid causing the severe adverse collateral consequence at issue.” Further examples of the types of collateral consequences include, a) the inability to fund pension obligations, b) the inability to provide capital, maintenance or equipment required by law or regulation, c) causes of layoffs, d) causes of product shortages, or e) causes of significant disruption of competition in a market.
Continued viability considerations
External auditors have an obligation to assess an entity’s future viability in conjunction with standard financial statement audit procedures. Pursuant to ASC 205-40-50-1, “In connection with preparing financial statements for each annual and interim reporting period, an entity’s management shall evaluate whether there are conditions and events, considered in the aggregate, that raise substantial doubts about an entity’s ability to continue as a going concern within one year after the date that the financial statements are issued.”
However, the scope of a financial statement audit does not approach the depth and expertise required when completing the questionnaire. Per AU-C section 570, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, auditors are required to obtain appropriate audit evidence on management’s use of the going concern basis of accounting, but there are inherent limitations acknowledged on the going concern evaluation, as “the auditor cannot predict such future conditions or events."8
Lastly, according to the memo, organizations should also evaluate that following:
- Current financial condition: As discussed above, this includes identifying an organization’s current assets and liabilities as well as analyzing current and anticipated cash flows against working capital needs, and assessing the underlying causes of any projected shortfalls, including whether owners withdrew capital or engaged in related party activity that lacked economic rationale, both of which would suggest that funds were drained from the business in an inappropriate fashion.
- Victim restitution considerations: This requires an evaluation as to whether the “proposed criminal fine or monetary penalty will impair an organization's ability to make restitution to any victims.”
- Alternative sources of capital: This requires an evaluation of an organization’s ability to raise capital through existing or new credit facilities or via a sale of assets or equity.
The new guidance reflects unprecedented transparency from the government as it relates to ability to pay implications, and signifies “the first time the DOJ has formally recognized that collateral consequences should factor into the fine or penalty determination."9
Organizations attempting to establish their inability to pay a fine should seek assistance from advisors with the requisite experience to evaluate the range of factors that can significantly affect a company’s future performance. Thoughtful discussion and collaboration between an organization’s advisors, the DOJ and the external auditors (while preserving independence) will be necessary in reaching a settlement, which embodies the goal of the memorandum.
1 Assistant Attorney General Brian A. Benczkowski Delivers Remarks at the Global Investigations Review Live New York
2 UNITED STATES SENTENCING COMMISSIONGUIDELINES MANUAL 2018
3 In November 2019, a leading seafood producer filed for bankruptcy, and the CFO cited a $25 million DOJ fine levied in 2017 for price-fixing, as well as millions in legal fees, as the primary cause. The penalty was eventually reduced from the original ruling of $136.2 million after it was determined that such an amount would jeopardize the future viability of the company.
4 U.S. Department of Justice Memo, Evaluating a Business Organization’s Inability to Pay a Criminal Fine or Criminal Monetary Penalty, October 2019.
6 Financial Accounting Standards Board (FASB) in August 2014 regarding ‘Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern.’ Accounting Standards Update No. 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern, FASB (Aug. 2014).
7 Presentation of Financial Statements— Going Concern (Subtopic 205-40)
8 The Auditor’s Consideration of an Entity’sAbility to Continue as a Going Concern
9 DOJ’s New Guidance on Inability-to-Pay Claims: A Clearer Path to Imposing Corporate Fines and Penalties