How We Ended Up Not Even Bothering To Prosecute Corporate Crime

As I've made clear in many prior posts, it is my firm belief that corporations will continue to brazenly break the law and pay the resulting fines as simply the cost of doing business until the government finally puts some senior executives in jail for a prolonged sentence. In fact, it is a wonder how we ended up in the situation where this never happens to begin with.

An article in the New Yorker outlines the history of corporate prosecutions since the 1970s. It all started in 1975 when the chairman of United Brands inexplicably committed suicide by jumping out the window of his NYC office. That suicide sparked the interest of an SEC investigator, Stanley Sporkin, who then uncovered the fact that United Brands was paying a $2.5 million bribe to the President of Honduras. With the chairman who authorized the bribe already dead, Sporkin felt that somehow United Brands should be held accountable for the bribery scheme. With the help of a prosecutor, Jed Rakoff, Sporkin developed a unique theory to try and bring the entire company to justice. In a sense, they were successful as United brands ended up paying a $15,000 fine (you read that right) and pleading guilty to conspiracy and wire fraud.

But Sporkin's idea, which was really based on the fact that the guilty executive was already dead and unable to face justice, created a sea change in the way corporate crime was prosecuted. After that case, charging the corporation become the method for prosecuting white collar crime instead of charging executives and individuals. The obvious problem with this strategy, from the viewpoint of justice, is that corporations can not be jailed. The only punishment available is to fine the corporation which, in publicly traded corporations, means that shareholders bear that cost even if individuals in the company have benefited from the crime.

While getting an admission of guilt and extracting a fine became the preferred method to prosecute corporate crime, there were occasional cases where individuals actually were tried, mostly for insider trading on Wall Street. But they were the exception to the rule.

The real turning point came with the massive fraud at Enron. Enron's accounting firm, Arthur Andersen, was complicit in Enron's fraud and the company engaged in a massive obstruction of justice by destroying evidence. When it was convicted of those crimes, the firm lost its accounting license and essentially folded, costing thousands of regular, law-abiding workers at the company their jobs.

The Andersen case made prosecutors totally gun-shy about seeking criminal guilty verdicts from companies simply because they did not want to be responsible for driving another company, and the associated jobs, out of business. So, rather than go back to the old way of prosecuting the individuals involved, prosecutors concocted another entirely new method to hold the corporation accountable, the deferred prosecution agreement.

A deferred prosecution agreement requires the corporation to not admit guilt but agree to cease whatever probable criminal behavior they were engaged in and, if the corporation repeated the behavior within some agreed upon time frame, it could be subject to prosecution. This solution was the worst of both worlds. No individuals were prosecuted and the company never admitted guilt. In addition, corporations were found to be repeatedly violating these deferred prosecution agreements and, rather than risking a real prosecution, the government and the corporation just agreed to pay another fine and engage in another deferred prosecution agreement. Basically, corporations learned that they will only be fined for their illegal behavior, never prosecuted, and they soon considered those fines as simply the cost of doing business.

Between the fall of Arthur Andersen and last year, the Department of Justice has amazingly agreed to over 400 deferred prosecution agreements. The fear of holding a corporation criminally liable and the reluctance to prosecute individuals within those firms is the reason that no company and no senior executive has been criminally charged in the wake of the massive financial fraud that accompanied the crisis of 2008.

As the New Yorker article points out, senior executives have also become increasing sophisticated about avoiding direct responsibility for illegal activities and the law requiring prosecutors show direct criminal intent makes convicting individuals even more difficult. Even blatant violations of the Sarbanes-Oxley law, passed in the wake of the Enron scandal, that required senior executives to sign off on the accuracy of financial reports have not triggered an attempted prosecution.

Jed Rakoff, now a judge and the man who unwittingly started us down the path to where we are today, is now advocating going after individual executives. He believes that even billion dollar fines are treated as the "cost of doing business" and that the deferred prosecution agreements provide no real deterrent. Instead, he suggests that "sending a few guilty executives to prison for orchestrating corporate crimes might have a far greater effect." I couldn't agree more. Hopefully, this approach will show up somewhere in the Democrats' "Better Deal".

Of course, prosecuting crime is not the only problem we have with corporations. The concept of the corporation was originally created to encourage economic activity by providing some liability protection to those managing the company. Since then, the Supreme Court has imbued the corporation with powers entirely unnecessary to enhance its original intent, such as the power of free speech and now the freedom of religion. But that is a whole other discussion best left to another day and another post.