January 17, 2005
Civil, Not Criminal Actions
Larry Ribstein has some very true and important things to say about the criminalization of corporate governance. It's a bad idea, chiefly because it doesn't work. The normal workings of the system generate plenty of evidence sufficient for a decision in a civil case involving alleged breach of fiduciary duty. They don't produce evidence sufficient for criminal proof beyond a reasonable doubt:
Ideoblog: Criminalizing corporate governance: After the Enron and Worldcom settlements against outside directors who did not participate in the frauds, one would think that the kingpins of the spectacular corporate collapses are really in trouble. Think again. As two NYT stories today remind us, Ebbers (who is set for his first trial) and Dennis Kozlowski of Tyco, who is set for his retrial for supposedly looting Tyco, are not slam-dunks. Ebbers can be shown as a sympathetic rags-to-riches character who was out of the loop as to the accounting. Kozlowski’s expenses (remember the shower curtain and the parties?) may have been authorized, or close enough to it that there was no criminal intent. The problem here is that these are criminal trials, and they never should have been. The prosecutors must try to pound the square peg of criminality into the round hole of day-to-day corporate governance. These should be state court fiduciary or contract cases, as Kozlowski points out in the NYT article....
Posted by DeLong at January 17, 2005 01:37 PM
I beg to differ.
Criminal complaints can work, but we have to treat corporations like the legal people that they are.
Arthur Anderson was basically sentenced to death.
This needs to happen so some other large firms, and then people will take corporate governance seriously.
Also: It wouldn't hurt if maga salaries and mega bonuses of executives require approval from the owners of those companies, i.e. the shareholders.
It would make it more difficult to game the system, andeliminate a lot of the incentives for fraud.
Posted by: Matthew Saroff at January 17, 2005 01:59 PM
In your view, is this because of poorly written or otherwise flawed laws, or is it simply endemic to corporate governance as it is currently constituted?
Posted by: djw at January 17, 2005 02:12 PM
...It wouldn't hurt if maga salaries and mega bonuses of executives require approval from the owners of those companies, i.e. the shareholders."
Absolutely! At least from a strong majority - say two-thirds- of the shareholders.
Posted by: bncthor at January 17, 2005 03:13 PM
I'm still in favor of the corporate death penalty- three strikes and the corporate entity is dissolved and the assets sold. And put a few directors in jail. That MAY get their attention.
Posted by: Palolo lolo at January 17, 2005 03:45 PM
This is a real problem. You can't hold a business accountable, because doing so would primarily hurt the low-level employees, not the executives. You can't hold the executives responsible, because it's impossible to prove that they "did it."
I would propose a new system where the stockholders are personally punished for corporate crimes. The punishment could be in the form of a fine levied directly against the stockholders, instead of against the corporate coffers. There are two advantages: one, it would be quite an attention-grabber for a stockholder to receive a letter in the mail notifying him that he's a criminal and that he owes a 5 dollar fine to clear his name. It's irrational, but people respond very, very negatively to that sort of thing - even if the fine is a very small amount in objective terms. I think the amount of "shakeup" you might get at the company would be disproportionate to the severity of the punishment. That's a good thing.
On the other hand, it might be impractical to fine a large number of people. An alternate method would be for the government to simply declare that the fine is to be paid in the form of stock. This could be implemented by simply having the corporation issue extra stock, thereby devaluing its existing stock, and turning over that stock to the government. The government would sell the stock on the open market. One interesting aspect of this approach is that in situations where a corporation is controlled by a few large stockholders, you're essentially taking away the corporation from people who can't be trusted to run it properly.
Posted by: Josh Yelon at January 17, 2005 03:45 PM
What do you think about Paul O'Neill's idea of changing the standard of corporate responsibility from recklessness to negligence? It made a lot of sense to me (and not just for corporate governance).
Posted by: fling93 at January 17, 2005 04:22 PM
One potential fly in the ointment for Bernie Ebbers is that he can't claim no knowledge of the accounting. He was famous for reviewing expense reports of those well down the chain. On the other hand, he did flunk out of college twice (as a pys ed major), so the "stupid defense" could work well.
In the major corporations where I have worked, the outside auditors were pretty involved in producing the actual accounting numbers. The same folks who were supposed to be doing the audit were effectively doing the accounting. They didn't so much do the bookkeeping as the massaging of the numbers. The liability for the accounting firms should be extreme.
I believe the accounting firms should receive payment from the SEC, at corporate expense. There is just way too much conflict to independence when the company can fire you. The large accounting firms are far too well compensated for what they do. However, most public companies are forced by underwriters to use of of the majors.
I also believe that internal auditors should have employment contracts, so that they can actually review the internal controls of the company without fear of retribution.
Posted by: RickG at January 17, 2005 04:54 PM
The problem with relying on civil cases is very simple. Have you heard the phrase "tort reform" bandied about lately? Wanna bet that any penalties great enough to get the attention of the upper echelons of corporate management will vanish?
Posted by: Jim S at January 17, 2005 05:59 PM
It does seem that we have criminalized too many things. Copyright violations, and violations of intellectual property in general should never have been criminalized.
However, the damage that people like Ken Lay, Ebbers, and Kozlowski is extensive. They bought up companies using fraud and then ruined them. To me, that's worse than starting up fake companies because fake companies don't have real employees that get screwed out of their jobs and pensions.
Posted by: Eric at January 17, 2005 06:34 PM
Who exactly is going to bring these civil actions? Shareholders? Get serious.
How many have anything like enough at stake to justify the stupendous legal expenses that would be involved? Remember that the officers and directors will have their legal expenses paid by the company, and so will the company itself, of course.
Before you argue against criminalizing these offenses describe an alternative scheme that both holds the individuals involved personally accountable and has a practical enforcement mechanism.
Then I'll listen.
Posted by: Bernard Yomtov at January 17, 2005 06:44 PM
So, corporations are artificial people (a theory found nowhere in the Constitution, even though its drafters were familiar with the concept of the joint stock company). But "they" can't actually be held accountable for anything they do, and neither can their fiduciary officers. Hmmm, that poses a bit of a problem.
In this context, what exactly does fiduciary mean? What does officer mean? What is the function of the corporate charter? And aren't civil fines just paid out of profits, meaning the little-guy employees AND the stockholders pay?
This line of reasoning leads one to think that corporations actually are alive, with brains and deliberate actions that spring from the id as it were. But in fact, in every large organization of which I have been a part there is a group of people somewhere who (a) know exactly what is going on (b) are reaping VERY large rewards from whatever is happening. You need to be a little more precise on why these people should not be held accountable for violations of criminal laws.
Posted by: Cranky Observer at January 17, 2005 07:22 PM
I like Josh's idea on making the fine payable in the form of stock (I've had similar thoughts myself). You have to make penalties apply to the stock price, which will properly incentivize companies to avoid penalties, lest they face a flight of shareholders (let alone a drop in value for management's own substantial holdings). And this will also cause shareholders to demand more control.
Posted by: fling93 at January 17, 2005 08:14 PM
I spent a number of years in securities law enforcement. I think that corporate executives can be deterred from fraudulent accounting, and most other crimes, by the threat of actual prosecution. However, since the Reagan administration, there has been a steady weakening of this threat, and gradually the SEC has become totally ineffective.
I remember going to a securities CLE convention in 1975. Stanley Sporkin made an appearance to talk about compliance, and there was a visible respect and an obvious fear of the man responsible for SEC enforcement. That would not happen today.
At the same time, there has been a total destruction of the notion of professional responsibility at the bar and among accountants. The downside of the money driven practice of these professions is the loss of any sense of responsibility to the shareholders and to the public at large.
These problems could be ameliorated if there were credible threats of punishment, either civil or criminal, but these have been eroded. There is a specific statute protecting professionals from all but the most egregious acts, and there are a number of procedural hurdles even then.
As to criminal prosecution, at the federal level, there are too many drug cases, and terrorism consumes the FBI, so the US Attorneys do not get the investigations they need for white collar crime. At the state level, there is little expertise in most states. Besides, in large corporations, responsibility is diffuse, and proof is difficult.
What did people think would happen when they voted for Republicans, anyway? That there would be constraints on capital? To quote Johann Strauss in Der Fledermaus: It's too funny, ha, ha, ha, please excuse me, ha, ha, ha, ha, ha, ha, ha, ha, ha, ha, ha, ha, HA!
Posted by: masaccio at January 18, 2005 06:06 AM
There is actually no real difference between a stock fine and a cash fine, since the corporation can easily convert one into the other, either isuing stock to raise the cash or using cash to buy back stock.
In any case, such fines punish a very large numebr of people with no direct responsibility for the relevant offenses, and probably do little to deter the "malefactors of great wealth."
What is needed is a way to punish the individuals, not the company.
Posted by: Bernard Yomtov at January 18, 2005 06:44 AM
Larry Ribstein was a professor of mine at GMUSL.
I dropped his class after 3 weeks. Why am I gratuitiously slamming him? Because nothing that comes from that font of conservative extremism should be taken at face value. He says "the laws in place don't work, criminal sanctions are inapplicable to white collar crime."
What he thinks (in my admittedly non-telepathic opinion) is that the bleeding edge of capitalism must be tolerated in order to realize the best benefits and efficiencies of the system as a whole.
Subconsciously, (I further assert), what he believes is that theft that you can argue your way out of is different than breaking into someone's house and taking their stuff, and should not be sanctioned. Because, he can envision doing the former, and not the latter.
In my opinion, however, a toleration of white collar crime feeds the perception and the REALITY of an unjust, two-tier society, where the privaledged (capitalists) may do as the masses (consumers) may not: take that which is not given.
You can only erode the social contract so far before violence breaks out. I fear market fundamentalists neglect this fact, to their (and everybody's) peril.
Posted by: Dave at January 18, 2005 07:41 AM
Connecting some of the dots presented in this thread: it is disheartening to think that someone can be sentenced under a three strikes law to life imprisonment for purse snatching grocery money from three people while white collar criminals will be laughing together at the country club over their countless number of victims from whom they have fleeced millions of dollars. It used to be Republicans wanted small government so it would get out of the way of the rich robbing the poor. Now they have seen the light. It is much better to have the government as a partner in crime. So let's also remember the power the Republicans hold when they appoint conservative judges. Massacio has it right.
Posted by: Dubblblind at January 18, 2005 10:49 AM