The Secret Life of - Hemming Morse, LLP

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“The Secret Life of Corporate Monitors” originally published in the December 2014 issue of California Lawyer. Reprinted with permission. 2014© Daily Journal Corporation, San Francisco, California

DAN W. RAY TURNS OVER CORPORATE ROCKS for a living, looking for anything illegal that might slither out. A forensic accountant with Hemming Morse in San Francisco, Ray is also a rare bird: He’s spent eight years as an FBI agent, and served twice as an independent monitor overseeing companies that negotiated deferred prosecution agreements (DPAs) with federal prosecutors in lieu of indictment and trial. “The Department of Justice is interested in whether a company’s internal controls and compliance program are robust,” Ray says. “A lot of companies have a policy manual. Do they use it, or is it a nice book sitting on the shelf?” DPAs and nonprosecution agreements (NPAs) have become the federal government’s bread-and-butter enforcement tool since its 2002 indictment of accounting giant Arthur Andersen for allegedly obstructing justice led the firm to implode, eventually costing 20,000 jobs. The Bush administration’s Justice Department then took up DPAs as a form of pretrial diversion, giving prosecutors a middle-ground alternative to the stark choice of whether or not to indict a corporation. By offering to put off prosecution, the government can command changes in corporate training and reporting programs, limit executive compensation, curb aggressive marketing, force the hiring of compliance officers—and require the company itself to fund an independent monitor. For companies facing criminal charges, a DPA was a way to avoid trial and damaging publicity. The trade-off: hefty fines and a promise to permanently reform corporate practices. From 1993 through 2003, the DOJ had entered into just 17 such agreements. By contrast, in the decade since 2004 prosecutors have arranged 278 DPAs. They have become a Pamela A. MacLean is contributing writer for California Lawyer.

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cash cow for the government, generating $12 billion in fines and penalties from 66 DPAs in the past two years alone. In its 2014 midyear update on DPAs and NPAs, Gibson, Dunn & Crutcher reports that the arrangements have led to “monetary penalties totaling more than $42 billion, equivalent to the annual GDP of Latvia.” Without naming the subjects of his monitoring, Dan Ray talked generally about the highly secretive world of government-appointed corporate monitors, where progress reports are confidential, judges rarely get involved, and the DOJ alone determines whether corporations have complied with terms of the agreements. Monitors are not government employees or agents, and they do not contract with or receive payment from the government. Fees generally are negotiated between the corporation and the monitor. During Ray’s first appointment, in 2005, the mission of DPAs was still evolving. The Justice Department offered no specific instructions for the prosecutors in its 93 U.S. Attorney’s offices, and corporate monitors often had unfettered authority. The board members at the company involved interviewed Ray and submitted his name to the DOJ as their choice for monitor. In those days, nominees not deemed “unacceptable” by the department were simply approved. “I wasn’t interviewed by the Department of Justice or the Securities and Exchange Commission,” Ray says. “That was standard then.” By 2012, when Ray got his second appointment, things had changed dramatically. After a series of scandals over particularly lucrative appointments, the DOJ imposed guidelines in 2008. The complaints included then–New Jersey U.S. Attorney Chris Christie’s appointment of his former boss, Attorney General John Ashcroft, to monitor Zimmer Holdings for a potential $52 million fee to Ashcroft’s firm, paid by the medical-device company. (In another DPA with Bristol-Myers Squibb in 2005, Christie had required the pharmaceutical giant to pay $5 million to fund a business ethics chair at Christie’s alma mater, Seton Hall University School of Law.) “The [selection] process became more formal and rigid,” Ray says of his second appointment. This time around, the company’s in-house and outside counsel vetted his nomination before it was submitted with a slate of candidates to the government, which made the final choice. “I flew to D.C. and was interviewed by DOJ and the SEC,” he says. As a finalist, he was asked to submit a proposal outlining how he would approach monitoring. He identified staff, checked for conflict-of-interest issues, roughed out a budget, and partnered with a law firm to cover legal questions. Nowadays, the problem is not that corporate monitors have gone awry—it’s that they are going away. The appointments peaked in 2008, when monitors were a component of 40 perCALLAWYER.COM | DECEMBER 2014


“If the companies didn’t satisfy the monitor, they had a potential trial hanging over their head.” —MONITOR DAN W. RAY, HEMMING MORSE

cent of all DPAs and NPAs. Since then, the rate has dropped NEITHER FISH NOR FOWL to just 25 percent of such agreements. In the first half of this Dan Ray’s career opens a window on what corporate monitors year, only three of twelve agreements included monitors. actually do. As a monitor, Ray says, “I met with the company’s Even when monitors are deployed, it is unclear whether highest-level executives, [and] from the chairman of the anyone at DOJ checks on the progress of compliance. The board down to the lowest member on the sales staff, to learn Government Accountability Office reported in 2009 that the if corporate compliance messages made it to the street.” In DOJ had lost twelve of the periodic reports from seven moni- both of his appointments, he toured overseas plants in tors they were expected to review, and in two instances it Europe, Asia, the Middle East, and South America with a could not even find copies of the agreements. team of up to four accountants and lawyers, looking for eviConsider the case of UBS AG, the Swiss banking giant dence of changed corporate attitude. Though he may not that signed a DPA in 2009 regarding tax-fraud allegations, have been welcomed with open arms, he says, neither was he and then entered an NPA in 2011 after a bid-rigging scandal treated like a pariah. on municipal investment contracts. In 2012 the bank’s Japa“The companies had the good sense to know the emphanese subsidiary pleaded guilty to wire fraud in a U.S. inves- sis of the DPA was on ‘deferred’ prosecution,” he says. “If tigation of interest manipulation of the London InterBank they didn’t satisfy the monitor, they had a potential [criminal Offered Rate (LIBOR). Federal prosecutors and trial] hanging over their head.” British and Swiss regulators secured about $1.5 In both 2005 and 2012, Ray says, “there was billion in fines. Despite these repeat offenses, last very little pushback to my work plans and February UBS sought U.S. and European immurequests.” The companies assigned someone to BILLION nity from prosecution in a probe of the manipulasmooth the way for site visits by identifying releMonetary tion of currency markets. vant documents and arranging interviews. penalties between Then in April, Hewlett-Packard Co. won a Despite his FBI roots, Ray adds, he was careful 2000 and June 2014 dubious trifecta by resolving three federal comnot to expand his inquiry—what is sometimes (equal to the GDP plaints accusing its subsidiaries—in Mexico, called mission creep. “I saw my role as a monitor, of Latvia) Poland, and Russia—of conspiring to bribe foreign not an investigator,” he says. In both assignments, officials in exchange for lucrative contracts. HP’s he encountered transactions that raised new conMexican unit entered into an NPA, its Polish unit cerns, but Ray states: “[A]s a monitor I was interagreed to a DPA, and its Russian unit took a plea ested in the company’s response. If the company deal for violating the Foreign Corrupt Practices didn’t investigate properly or take it seriously, I Act. The three HP entities paid $77 million in crimiwould raise the question, ‘What are you going to nal penalties, and in a related matter settled with the do about this?’ ” Number of DPA and NPA SEC for an additional $31 million in disgorgement. In his first appointment Ray filed reports with agreements the What HP managed to avoid was getting a corporate the DOJ’s Foreign Corrupt Practices Act unit every DOJ and SEC monitor to oversee the company’s future conduct. six months for three years, and annually with the entered during “The elephant in the room is lack of monitorSEC. He rarely got feedback. But by 2012, he those dates ing,” says Brandon L. Garrett, a criminal procesays, “It was clear DOJ was reviewing reports and dure specialist at the University of Virginia’s law they offered comments. I met with them in D.C. school. “But when prosecutors do pick them, they on several occasions. There was much more pick from among their own. They pick former involvement.” prosecutors. Monitors should be picked with a By 2012 the DOJ also had begun approving judge,” Garrett says. hybrid plans. The company he was assigned to Of the 290, more Monitors “don’t report to court,” he continues. had to submit to an independent monitor for than half have “We don’t know what they do. Not even a portion the first 18 months; if Ray was satisfied with its come since 2010. of the reports is public. It is entirely a black box.” progress, the company could self-monitor for






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the remaining term of the agreement. Ray said he shared drafts of his reports with the company before filing them with DOJ. “If I was describing internal controls, [seeing a draft] gave the company the ability to review and propose edits to make it factually correct,” he says. “The big thing was recommendations. We had a lot of dialog about that.” Ray said he did not feel pressured to soft-pedal advice, but acknowledged it was a “fine line.” “I’m not an agent of the government, nor an employee of the company,” he says. The companies were fervent about the confidentiality of his reports, Ray says, out of fear they might fall into the hands of stockholders. “If [a monitor] identified internal-control deficiencies, can a lawsuit be initiated by class action counsel? Companies don’t want that information used against them in court.”

Former U.S. Attorney Debra Wong Yang monitored DePuy Orthopaedics as part of a DPA. James M. Cole was twice appointed to monitor AIG Financial Products.



in Texas ordered Yang to give a deposition as part of trial Corporate fears about disclosure of the terms, conditions, preparation for the first of more than 6,000 cases against and progress of a DPA or an NPA are not unfounded. Factual DePuy and its parent, Johnson & Johnson, over design of admissions might be used under Federal Rule of Evidence the Pinnacle hip implant. (Herlihy-Paoli v. DePuy Ortho801(d)(2), and have been used successfully by plaintiffs law- paedics Inc., 12-CV-04975, which is part of In re DePuy yers against pretrial motions to dismiss. In 2009, for instance, Orthopaedics Inc., Pinnacle Hip Implant Prod. Liab. Litig., U.S. District Judge Jeffrey S. White in San Francisco relied on 11-MD-2244 (N.D. Texas ).) In late October jurors found no Stryker Orthopaedics’ 2006 NPA to deny a motion to dis- liability for the defendants. miss. (Somerville v. Stryker Orthopaedics, 2009 WL 2901591 In the course of researching his newly released book, Too (N.D. Cal.).) Big to Jail: How Prosecutors Compromise with Corporations A North Carolina case followed Judge White’s tack, rely- (Harvard University Press), the University of Virginia’s Garing on developer Beazer Homes’ acceptance of responsibility rett had to file suit under the Freedom of Information Act to for criminal acts in a prior DPA to keep alive a civil com- get access to one sealed DPA involving a Texas tree service. plaint with similar allegations. (See Davis v. Beazer Homes, After the government finally turned the document over, USA Inc., 2009 WL 3855935 (M.D. N.C.).) In 2012, however, a federal judge in “We don’t know what Louisiana presiding over the multidistrict [monitors] do. Not even a Deepwater Horizon litigation against BP prevented a jury from receiving evidence portion of the reports is public. about a DPA that resolved an earlier acciIt is entirely a black box.” dent at a BP oil refinery in Texas. (See In re —BRANDON GARRETT, Oil Spill by Oil Rig “Deepwater Horizon,” UNIVERSITY OF VIRGINIA LAW PROFESSOR 2012 WL 413860 (E.D. La.).) But even if a court can consider a DPA or an NPA, keeping a private cause of action alive is not the same as holding a company liable. In one of the Garrett says, he found himself scratching his head about why few appellate assessments on this question, the Ninth Circuit anyone would care about keeping it secret. Now Garrett, and reversed a summary judgment that favored a plaintiff in 2010. the law school’s First Amendment Clinic, have another 30 The appeals panel held that the admissions in a DPA proved pending FOIA requests to unseal DPA deals. the defendant defrauded the United States, but did not prove At least one federal judge has made clear his distaste for that the fraud caused the plaintiff’s injury. (See Renzer v. Bayer- the entire nonprosecution approach. U.S. District Judge Jed ische Hypo-Und Vereinsbank AG, 630 F.3d 873 (9th Cir. 2010).) S. Rakoff of the Southern District of New York, in a January Debra Wong Yang, a partner at Gibson Dunn’s Los Ange- 2014 article in The New York Review of Books, suggested that les office, was appointed in September 2007 to monitor “the future deterrent value of successfully prosecuting indiDePuy Orthopaedics as part of a DPA reached with four viduals far outweighs the prophylactic benefits of imposing medical-device companies charged with conspiring to vio- internal compliance measures that are often little more than late the federal antikickback statute. In July a federal judge window-dressing.” COMMENTS? [email protected]




Reisinger’s lawyer, J. Joshua Wheeler, director of the Thomas Jefferson Center for the Protection of Free Expression in Charlottesville, Virginia, contends, “What’s important is the public’s right to know … what the DPA requirements are. We may think they are insufficient. Are these decisions the public would be comfortable with? We don’t know. The government is just saying, trust us.” In April 2012 U.S. District Judge Gladys Kessler denied access on First Amendment grounds, noting that the SEC had brought a civil, not criminal, action against AIG, and that Reisinger had not made the requisite showthat access “has historically been available.” “Ultimately, [prosecutors] are just playing ing (SEC v. Amer. Int’l Group, 854 F. Supp. 2d 75, 79 judge and jury in most of these cases. (D.D.C. 2012).) But Kessler did grant a common It is an enormous regulatory power grab.” law right of access, holding that the monitor’s reports are properly considered judicial records —JAMES R. COPLAND, MANHATTAN INSTITUTE and “may prove critical to this Court’s assessment of conformity to the Consent Order.” (854 F. Supp. 2d at 81.) D.C., office of Bryan Cave, to monitor reforms at its AIG A year later, however, the D.C. Circuit Court of Appeals Financial Products subsidiary. Cole was specifically charged reversed. Writing for a three-judge panel, Judge Janice Rogwith reviewing certain structured financial transactions. He ers Brown held that Cole’s reports were “neither judicial was reappointed in February 2006 pursuant to a second records nor public records.” Brown added, “Indeed, the indeagreement, this time monitoring financial reporting and pendent consultant had no relationship with the court. The corporate governance. Cole was filing periodic reports dur- court did not select or supervise the consultant and had no ing a four-year period leading up to the financial crash of authority to extend the consultant’s tenure or modify his 2008. Yet it took a $182.5 billion taxpayer bailout—since authority. … Unfortunately for Reisinger, the value of the repaid—to help AIG recover from the effects of the transfers reports for proper oversight of the Executive does not itself Cole was supposed to be tracking. justify disclosure under the judicial records doctrine.” (SEC When Congress learned of Cole’s presence inside the v. Amer. Int’l Group, 712 F.3d 1, 4–5 (D.C. Cir. 2013).) company—for which AIG paid his law firm some $20 million—it demanded access to his monitor reports. Although CALLS FOR REFORM the district court granted a joint motion in 2006 prohibiting Efforts by Congress to reform DPAs—initially set in motion public dissemination of the reports, at the request of the SEC following exposure of Christie’s appointment of John Ashand AIG the court granted release of reports to the congres- croft as a monitor in 2007—have gone nowhere. sional Office of Thrift Supervision, and to the House ComCongress first proposed uniform national standards for mittee on Oversight and Government Reform. But the DPAs and NPAs in 2008. The legislation was deferred in releases stopped there. March of that year when the Justice Department issued When Sue Reisinger, a reporter for Corporate guidelines to U.S. Attorneys. Known as the MorCounsel, requested public access to Cole’s reports ford Memorandum—after Craig S. Morford, the in 2011, the SEC and AIG opposed disclosure. former acting U.S. deputy attorney general—the Reisinger argued that the documents are analonine enumerated “Principles” were intended to Highest annual gous to those supporting a plea agreement in a avoid the perception that monitor jobs were politnumber of DPA/ criminal trial, and are therefore entitled to a preical plums for insiders. The principles emphasized NPA agreements sumption of access under the First Amendment. the monitors’ independent role, the limited scope (in both 2007 She also argued that the reports should be publicly of their work, and the need for them to commuand 2009) available under the common law right of access to nicate progress through periodic reports. They judicial records. required that monitoring contracts be approved In an interview, Reisinger comments, “Cole by the DOJ’s chief of the criminal division and the was appointed to oversee the very unit that almost second-ranking department official—currently caused AIG to go bankrupt. If this case, with the former AIG monitor James Cole. strong public interest and clear implications of In 2010 the DOJ set more restrictions on the DPA/NPA what AIG did to our economy, isn’t important selection of monitors in a memo issued by acting agreements enough to trigger a right of public access, I don’t Deputy Attorney General Gary G. Grindler. The in 2012 know what is.” Grindler Memo required prosecutors using a DPA Indeed, lack of public access to the monitors’ reports—and of judicial review when monitors can’t compel compliance with the terms of DPAs —make it difficult to defend the continued use of corporate monitors. Consider the American International Group Inc. matter. AIG entered a consent decree with the Justice Department and the SEC over alleged securities violations in November 2004, and two months later it accepted appointment of James M. Cole, then a lawyer in the Washington,




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or NPA to spell out the role the DOJ would play in resolving any disputes between the monitor and the company over compliance with terms of the agreement. That memo coincided with the start of a precipitous decline in the use of monitors. By 2014 even the biggest DPAs frequently omitted oversight. The granddaddy of them all came in January, when JPMorgan Chase, the nation’s largest bank, signed a DPA based on two felony violations of the Bank Secrecy Act Former U.S. Attorney General John Ashcroft (left) held a lucrative contract monitoring Zimmer Holdfor its role as a cash depository for ings. Michael R. Bromwich (with U.S. Sen. Dianne Feinstein) has struggled for access to Apple. Bernie Madoff’s Ponzi investment scheme. JPMorgan would pay the government $1.7 billion, “It’s good when a company feels it can fight back,” says accept responsibility, and cooperate for two years. Though James R. Copland, a senior fellow at the conservative Manthe deal calls for “significant remedial changes,” no monitor hattan Institute policy center in New York. was appointed to supervise the process. “The entire process is an affront to the rule of law,” CopCurrent legislative calls for reform and clear guidelines land continues. “I do think monitors are a problem—but the from the DOJ have been largely ignored. The Truth in Settle- bigger problem is the ability prosecutors wield to change ments Act (S. 1898), introduced in January by Sen. Elizabeth business models, change management, and effectively approWarren (D-Mass.) and Sen. Tom Coburn (R-Okla.), would priate levies as they see fit for purposes not closely tethered require transparency about the terms of deals between federal to the alleged misconduct. Ultimately, they are just playing regulators, the DOJ, and companies accused of wrongdoing. judge and jury in most of these cases. It is an enormous reguIt passed one Senate committee in September and stalled. latory power grab.” A second bill introduced in May by Rep. Bill Pascrell But Copland adds, “At the end of the day, I don’t think (D-N.J.) would require the attorney general to issue guide- DPAs do much. They tax shareholders with corporate mislines for DPAs and NPAs, and make the agreements publicly deeds by levying a tax on misdeeds of the past without testavailable online. The Accountability in Deferred Prosecution ing the theory.” Act of 2014 (H.R. 4540) is awaiting committee action. This year the veil of secrecy shrouding monitors’ reports In contrast, the United Kingdom published a DPA Code lifted partially when Apple Inc. challenged provisions of a of Practice in February 2014 governing the use of DPAs by court judgment that crown prosecutors. It establishes clear judicial roles, limits included a monitorship. “Apple was doing prosecutorial discretion, and allows broad public access. After a civil bench trial in its best to slow U.K. authorities may offer a DPA only if it includes a state- June 2013, U.S. District ment of facts related to the alleged offense, “which may Judge Denise Cote in New down the process, include admissions made by” the person or company York found that Apple if not stonewall.” involved. After nonpublic negotiations begin, the prosecutor had violated Section 1 of —U.S. DISTRICT JUDGE must ask the Crown Court judge to declare that the pro- the Sherman Act by con DENISE COTE posed terms are “in the interest of justice” and are “fair, rea- spiring with five e-book sonable and proportionate.” (See U.K. Crime and Courts Act publishers to fix prices. 2013, Ch. 22, at pp. 295–306.) (See United States v. Apple In the United Kingdom, a proposed DPA is not binding Inc., 2013 WL 4774755 (S.D.N.Y. Sept. 5, 2013).) A month on the court, and if rejected it would subject the company to later the court appointed Michael R. Bromwich, a former potential prosecution for the original allegations. The final DOJ inspector general, as monitor to review and suggest DPA will be published and approved in open court, and the improvements to Apple’s internal antitrust training and comruling is nonappealable. Unlike in the United States, prose- pliance programs. Bromwich, a partner at Goodwin Proctor cutorial decisions pursuant to the DPA Code can be chal- in Washington, D.C., had two decades of oversight work in lenged through judicial review. both government and the private sector, including as monitor of “one of the largest companies in the world.” PUSHBACK Apple appealed the judgment to the Second Circuit, conThe strongest pressure regarding DPA policy in the United tending that Judge Cote’s monitoring provision exceeds the States is coming from business lobbyists and corporations. district court’s authority and violates the separation of powers. COMMENTS? [email protected]



way out of criminal prosecution. “The problem with the DPA is The monitor’s demands to that it is an easy cop-out for the Jus“crawl into the company” vastly tice Department,” says plaintiffs lawyer Richard Greenfield of Greenexceed the scope of the final field & Goodman in New York. “In judgment. so many cases [the prosecutors] —THEODORE BOUTROUS JR., GIBSON, DUNN & don’t have the resources to go to CRUTCHER, IN AN APPELLATE BRIEF FOR APPLE INC. trial—and the SEC goes through the same thing. So they issue a DPA.” Greenfield says deferred proseNevertheless, this year Bromwich’s reports, partially redacted, cution agreements could really have “teeth” if the governwere filed publicly. ment appointed tougher monitors, citing the example of Bromwich’s first report, filed in April, complained of oversight in union prosecutions in the 1990s. “It cleaned up Apple’s lack of cooperation. Judge Cote fumed, charging the Teamsters by having a strong monitor in place,” he says. that Apple was “doing its best to slow down the process, if According to Greenfield, the greatest chance for success not stonewall.” comes with a judge-appointed monitor. And public discloBromwich’s second report, in October, noted a “more pro- sure of the monitor’s subsequent reports also serves the interductive and constructive” relationship, but he described con- est of shareholders in answering the basic question: “Is the tinued “attempts to limit and delay access to relevant personnel company complying, and what are they doing?” and materials.” In his summary, Bromwich stated that some But prosecutors’ leverage depends on the industry, accordrequests were rejected, others ignored, and the company ing to Kathleen M. Boozang, a Seton Hall law professor at the “inappropriately limited” the team’s live monitoring of antitrust Center for Health and Pharmaceutical Law and Policy. Prior compliance training sessions and other relevant activities. DPAs entered with medical-device, military-equipment, and After initially being denied interviews with top officials, financial companies carried an implicit threat of debarment Bromwich did meet with Apple CEO Tim Cook and other from contracting programs or loss of banking licenses for executives. He also noted that the company’s failure to supply its board of directors with his first compliance report was “surprising and disappointing,” given the Apple board’s “The DPA is an easy cop-out for the oversight role. Justice Department. In so many Meanwhile, Apple’s lawyers at Gibson Dunn were attacking cases [prosecutors] don’t have the Bromwich’s appointment from every angle. In a January letter to Judge Cote three months into the monitoring arrangement, resources to go to trial. … So they Gibson Dunn partner Theodore J. Boutrous Jr. asked that issue a DPA.” Bromwich be removed, alleging he had a personal bias against —RICHARD GREENFIELD, PLAINTIFFS LAWYER the company, collaborated with plaintiffs to expand his mandate beyond the terms of the final judgment, made excessive financial demands on the company, and evinced “adversarial, inquisitorial, and prosecutorial communications and activities noncompliance. Consumer technology companies like toward Apple since his appointment.” Apple don’t face those risks. Boutrous reiterated those charges in an appellate brief, argu“It’s like a game of chicken,” Boozang says. Prosecutors ing in May that Bromwich’s demands to “crawl into the com- don’t necessarily want to use their “nuclear option” in some pany” vastly exceed the scope of the final judgment and his sectors if it would reach outcomes like the demise of “unprecedented” fees create a financial incentive that violates Arthur Andersen. Apple’s due process rights. If allowed to stand, Boutrous conBoozang says the government may need to introduce tended, the ruling “will stifle innovation, chill comnew enforcement tools, and there are early glimpetition, and harm consumers.” Oral arguments on mers of change. A few DPAs with health compaApple’s appeal are scheduled this month. (United nies, for example, now include requirements for States v. Apple Inc., No. 13-3741 (2nd Cir.).) personal accountability—certification by offiBILLION cers and directors that specific conduct has been “A GAME OF CHICKEN” achieved—and provide for the clawback of Monetary To plaintiffs lawyers, federal prosecutors’ secret executive compensation if violations are found. recoveries in 2012, the record year agreements with huge corporations—even when “The shift to holding individuals to account has (2006 had they include limited oversight from companybeen significant,” she says. “It has gotten peo$5.9 billion) paid monitors—allow the firms to buy their ple’s attention.” CL




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