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Keeping the CEO out of jail: the risks of an environmental audit.

THE PRESIDENT OF A MASSACHUSETTS METAL FINishing company was sentenced to serve a 26-month prison sentence, placed on two years probation and ordered to pay a $400,000 fine or criminal violations of the Clean Water Act, including charges of placing the company's employees in imminent danger of death or serious bodily harm. An offier of a Tennessee electroplating company received a 40-month jail sentence for violating hazardous waste disposal regulations, and an oil company received a $200,000 fine for investigating a contaminated site without prior state approval.

The aggressive enforcement of environmental laws by prosecutors at both the state and federal level and the imposition of increasingly severe penalties is on the rise. Criminal penalties are becoming more common. In 1991, the Environmental Protection Agency reported that defendants convicted of environmental crimes served prison terms totaling 550 months, an increase of 121 percent from the previous year. Government costs recovery actions for the disposal of hazardous waste are also increasing, as is the likelihood that courts will find corporate officers personally liable for those costs. Claims by private parties regarding hazardous waste and toxic torts continue to proliferate.

Many organizations view the risks associated with non-compliance as so significant that they are conducting environmental audits, either internally or by using expert consultants, to identify compliance issues. Although increased enforcement activity is one of the more compelling reasons to manage environmental risk with an environmental audit, other benefits may result. These include the creation of an environmental compliance program which is put into effect over time rather than in response to a crisis. An audit also enables a company to prevent environmental violations before they occur and encourages the integration of environmental issues into production-related decision making. Most importantly, an overall environmental compliance program, which includes periodic audits, may help to persuade prosecutors to reduce penalties imposed for violations.

Environmental audits are similar to financial audits conducted by most businesses except that they focus on environmental issues. In addition, procedures are not nearly as well-established as those that relate to financial audits. While this lack of definition may allow greater flexibility for an environmental audit, if one is performed without sufficient planning and a commitment to act on its results, unexpected liabilities could accrue. These liabilities may affect not only the company, but also its executive management. In other words, based on information obtained from an audit, a company can unintentionally develop a detailed record that could be used to incriminate itself. That information may also trigger certain governmental notification requirements.

Severe Penalties

Although environmental concerns have been in the public eye for many years, recently the idea that there is an inordinate risk associated with environmental degradation has become increasingly popular. A consensus has developed that penalties for degrading the environment should be severe. Many government officials now believe that civil fines, which were originally intended to make environmental law violators "pay back" any economic benefit received by violating those laws, do not sufficiently deter environmental abuses. Some prosecutors believe that penalties need to be increased. It was not too long ago when judges would not consider enviromental issues, such as wetlands filling, to be as serious as other crimes, such as armed robbery. Recently, however, criminal penalties, including prison sentences, have been imposed in environmental cases.

Increased political pressure, stiffer laws and the acceptance of broader judicial interpretations regarding management responsibility in assuring compliance, have made severe punishment for environmental crimes more acceptable. There are now significant penalties imposed for noncompliance, and there is a judicial system that is prepared to impose those penalties. Certainly, significant liability is no longer only associated with hazardous waste matters; it now extends to many environmental programs. The following are some recent examples:

* The Clean Air Act amendments of 1990 provide authority for government agencies to seek significant financial and criminal penalties. It states that up to $1 million in fines and 15 years in prison can be imposed for "knowingly" releasing hazardous air pollutants, and $250,000 in fines and five years in prison can be imposed for a first offense involving violation of permits or administrative orders. Early uniform sentencing guideline proposals (which have been completed for act of violence and white collar crime, but are yet to be completed for "environmental crime") specify the same mandatory base line sentencing criteria for the violation of environmental statutes as for the possession of heroin.

* Courts have broadly interpreted the concept of a "knowing violation." If one is in a position to know, but in fact did not know, one still could be charged with a "knowing violation." This situation could also arise when information was given to a responsible manager who did not want to receive it.

* The Massachusetts Lawyers Weekly recently reported that jurors are likely to assume companies accused of violating environmental regulations are guilty. With a lower level of confidence in political leaders' ability to solve environmental problems, jurors apparently hope that "severe legal punishment will prompt polluters to become more responsible."

* Even U.S. government employees are subject to these risks. In a recent federal court decision, three civilian managers were convicted of hazardous waste violations under RCRA at the U.S. Army's Aberdeen Proving Ground in Maryland.

Government enforcement agencies do not believe they have adequate human of financial resources, and these agencies intend to pursue high-visibility enforcement actions. Environmental crime strike forces and sting operations are becoming common. Agencies faced with limited resources are relying more on stiffer penalties to stimulate greater self-enforcement. The increased use of strict liability standards by government enforcement officials and private parties has resulted in more findings of liability without demonstrating fault. In addition, statutory provisions have made it easier for prosecutors to demonstrate a "knowing" violation.

Audit Risks

Although there are many benefits associated with an environmental audit, if an audit is not conducted in a planned and thoughtful manner, it could produce significant problems. For example, the existence of an audit can be used as evidence of a "knowing" violation, both by senior management and operations level employees. Also, the audit report may not remain confidential: It may discovered in litigation or requested as part of a governmental investigation. Audit information in the hands of the government can be available to other parties through the Freedom of Information ACt; therefore, a private party may obtain a copy of the audit. This information may result in reporting requirements to federal, state or local authorities. In addition, never rule out that the report could be revealed by disgruntled employees.

On the upside, as previously noted, prosecutors consider good-faith efforts to manage environmental problems in deciding whether to pursue criminal or civil penalties. In determining which penalties will be adequate for the settlement, audits and a proactive environmental management program are favorably considered.

Therefore, one of the most important factors in deciding whether or not to conduct an environmental audit is that senior management must be committed to correct any problems resulting from an audit. Nothing could be worse than documented evidence of a violation that senior management is aware of (or is deemed to be aware of), but about which neither the company nor its management has taken any action based on that knowledge.

Keeping Confidential

The risk manager should address how to maximize the likelihood that the audit report will be respected as being confidential under the law. Although there is no guarantee, certain steps can be taken to increase the likelihood of the report remaining confidential. Two traditional privileges that may apply to the report are teh attorney-client communication privilege and the attorney work product privilege. A third qualified privilege concerning self-critical analysis is developing, but to date has achieved only limited success. The theory behind this privilege is that allowing an analysis to remain confidential provides an incentive to conduct audits and solve problems uncovered through the process.

The attorney-client communication privilege applies to communications in which the client seeks the advice of an attorney. The privilege must apply to the communication and cannot have been waived. As a result, if the privilege is to be preserved, the audit must be an effort to provide legal advice and not simply part of ongoing business operations. The privilege also applies to communications between the client and an attorney's agent, such as a consulting engineer. The same is not always true, however, of communications between the attorney and an agent of the client. The privilege only applies if information given to the attorney comes directly from the client. These rules illustrate the difficulty in maintaining complete confidentiality of an audit report.

Frequently risk managers or other corporate management personnel will direct a lawyer to perform the audit and to render legal advice regarding its contents. The likelihood of the report remaining confidential will increase if the attorney, rather than the client, retains the necessary consulting engineer. Throughout the process, relevant documents and communications should be marked confidential and subject to the attorney-client privilege to demonstrate the necessary intent.

The attorney work product privilege applies to information that is prepared "in anticipation of litigation." The privilege is not absolute except for the mental impressions of an attorney, which may be evidenced by an attorney's notes during the course of interviews with relevant personnel. Here too, documents prepared in the ordinary course of the client's business are not within the scope of the privilege. For the attorney work product privilege to apply, a company must demonstrate an anticipation of litigation, possibly in connection with government enforcement efforts. However, because these privileges vary with each jurisdiction, it is important to consult an attorney so that the proper steps are taken in conjunction with an audit report.

There are significant risks associated with the failure to comply with environmental requirements. Enforcement activities are resulting in fines and prison sentences, which are likely to increase in the future. Companies are trying to reduce these risks by conducting audits. These audits, however, can have the reverse effect if proper safeguards are not taken by management.

Although problems may arise during an audit, the risk of non-compliance is still better managed by conducting one. In so doing, the risk manager should help ensure that anticipating and respond to environmental problems does not increase risks for the firm and its management. When an audit is commissioned, either internally or externally, senior management must support the effort and the company should be prepared to respond to its results. The audit can be managed to achieve environmental compliance and to lessen the risk of environmental enforcement efforts.

Ned Abelson is a partner-law firm of Goulston & Storrs in Boston, and John Balco is associate principal of GZA Geo-Environmental Inc. in Newton, MA.
COPYRIGHT 1992 Risk Management Society Publishing, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
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Title Annotation:includes related article on avoiding pitfalls of an audit
Author:Abelson, Ned; Balco, John
Publication:Risk Management
Date:Feb 1, 1992
Words:1783
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