A Tale of Two Criminals: We’re Tougher on Corporate Criminals, But They Still Don’t Get What They Deserve

Sarbanes-Oxley: Going Too Far? [Part III]

While Enron was big news, in the end, it was just one of a number of stories about financial fraud that involved billions of dollars and involved the corruption of corporate executives, bankers and accountants. According to John Coffee, a Columbia Law School Professor, “from 1990 to 1997, earnings restatements averaged 49 a year. In 1998 they soared to 91; the next year there were 150; and in 2000 there were 156.” He also notes that stock analysts lost their skepticism during the same period: “In 1990 they issued six ”buy” recommendations for every ”sell.” By 2000, the ratio was nearly 100 to 1.”[24] John Bogle, Founder and Former Chairman of Vanguard Mutual Funds, notes: "of 1,028 stock recommendations made by the typical brokerage firm during the first quarter of 2001, only seven were "sell" recommendations. (As late as October [2001], 18 out of 20 analysts still rated Enron a buy)." 

The picture here is of a deep and systemic problem that mirrored what happened at Enron where banks became ”partners in crime” because of the fees, which was an incentive to rein in critical stock analysts who were providing a service to the public by asking the right questions. Fortune asks, “Did the banks know these transactions were deceitful? Without question – as their e-mails make abundantly clear. ‘Enron loves these deals,’ wrote a Chase banker in 1998, ‘as they are able to hide funded debt from the equity analysts.’”[25] Accountants fudged audits because of lucrative consulting fees, and evidence shows they too knew what they were doing. The problem is that everyone was making money off Enron, so no one blew the whistle. Boogle outline the full scope of the problem;

The New York Times accurately describes the Enron mess: "A catastrophic corporate implosion . . . that encompassed the company's auditors, lawyers, and directors . . . regulators, financial analysts, credit rating agencies, the media, and Congress . . . a massive failure in the governance system." Of course, there are those who would say those harsh words are an over-reaction, alleging that 99.9% of audits of publicly-held companies are problem-free and that nearly all corporations have ethical managements and auditors who are truly independent. But just because nearly all commercial airline flights are problem-free and nearly all pilots and passengers are law-abiding citizens doesn't mean we should ignore the catastrophe of September 11 and stand idly by without beefing up airport security. Nor, after Enron, should we stand idly by without beefing up corporate governance. But not just because of Enron. For in the great bull market of 1982-2000, all sorts of subtle—and not so subtle—abuses have crept into corporate reporting, and the integrity of our financial markets has been compromised. [Just When We Need It Most...: Is Corporate Governance Letting Us Down? Remarks by John C. Bogle Before the New York Society of Security Analysts, February 2002]. 

The Sarbanes-Oxley legislation, which went beyond the minimalist reforms President Bush requested and which was billed as the most far reaching financial reform since the Depression, was supposed to fix these problems with the system. However, the ink was no sooner dry on the legislation than “members of Congress from both parties accused the administration of undermining or narrowing the scope of provisions covering securities fraud, whistle-blower protection and punishment for shredding documents.” Critics, including the bill’s authors, charged that the Justice Department drew up interpretations and prosecution guidelines that contradicted the legislative intent of the reform measure.[26] By November of 2002, the Washington Post reported: “Harvey L. Pitt's resignation from the Securities and Exchange Commission, coupled with the Republican Party's success in the midterm elections, has emboldened some Wall Street executives to stiffen their resistance to strong reforms that only days ago seemed almost certain, industry and regulatory sources say.”[27] 

The problem that Sarbanes-Oxley had to address was not ”a few bad apples” but ”business as usual.” Changing ”business as usual” does involve significant change that needs to target all the problems: investment bankers, stock analysts, accountants, outside directors, and allegedly clueless CEOs who are paid millions but somehow are not responsible for anything bad. Further, deterring misconduct was an important goal – needing to send the message that misconduct will not be tolerated. The target audience of slick executives needs a strong message. As noted by Donald Langevoort, a professor at the Georgetown University Law Center and a former lawyer for the Securities and Exchange Commission: "A lot of these people think they can talk their way out of anything, and with all their power, their contacts, their cleverness, they can be fine.”[31] 

Lest you still think that business can be trusted to regulate itself, along comes the mutual fund scandal, which lost out to Martha Stewart in press coverage even though it involved considerably more wrongdoing and victims. A deputy to New York Attorney General Spitzer, who was far ahead of the Securities and Exchange Commission, commented that “a whole grotesque industry [grew] up based on screwing small investors. It’s about as bad as it gets.”[32] Mutual fund companies allowed select investors to place trades after the 4 pm closing bell when prices have been set, a practice compared to allowing someone to place a bet after the horses crossed the finish line. (Some of the trade requests came as late as midnight.) Although such market timing is not illegal when properly disclosed, mutual fund companies said publicly they didn’t allow it, but did allow favored clients to do so, even though the practice creates costs that are shared by the people who play by the rules.[33] And, “just as with the other corporate scandals, banks helped enable the illegalities – and then helped cover them up.”[34] 

See PaulsJusticeBlog: Ebbers' 25 Year Sentence for Worldcom Fraud Upheld. Good.

More Political Cartoons: Enron ~ Bush & Corporate Crime ~ Corporate Follies ~ Worldcon ~ Ken Lay's arrest ~ Ken Lay's Death.

Undermining Sarbanes-Oxley’s provisions or denying the importance of full extent of the reforms are the first steps in recreating the deregulated environment in which the recent spate of frauds occurred. It would seem that, after such enormous financial catastrophes, this shouldn’t be an issue, but history tells us differently. Indeed, the quote at the end of the introduction notes that after the Savings and Loan scandal that cost a half trillion dollars, Congress went on a deregulation binge! According to a New York Times article: “In an eerie flashback to the savings and loan scandal a decade ago, it turns out that some of the same lawmakers and regulators investigating some of the causes behind the Enron-Arthur Andersen scandal – Democrats and Republicans alike – may need to look no further than the mirror.”[35] The article suggests that some of these very investigators were responsible for “legislation that shielded companies and their accountants from investor lawsuits [and forced] regulators to dilute proposed restrictions on accountants.” 

Many of these attempts to water down legal restrictions were the result of industry lobbying and campaign donations, which brings up a final lesson worth emphasizing. Many people seem to think that, because politicians did not help Enron in its final desperate moments, Enron’s political donations did the company no good. However, John Dean, legal counsel to former President Nixon, noted in a column for Findlaw.com that: “Enron's contributions may have helped slow detection of its troubles, and helped the company fly under the radar for as long as was possible given what now appear to be some egregious accounting and business practices.” Further, 

when Enron hit the wall, the Bush Administration remained mute, even knowing Enron was disintegrating. Certainly the former governor of Texas had some idea of what this would mean to his beloved state. For one thing, twenty thousand employees of Enron would be out of work, with their 401(k) plans worthless. Surely a man with a Harvard MBA could envision the devastation this business failure (of a company he had once promoted) would have on countless thousands of Enron stock and bond holders, not to mention major lending institutions who had provided Enron working capital. 

In all these ways - through favorable regulatory changes, lack of government oversight, and administration silence until the very end - Enron's investment in Washington paid handsome returns for a few insiders, who personally made millions (but obviously wanted billions) from Enron. Sometimes buying influence can simply mean buying silence - not buying specific actions or intervention.[36] 

Conclusion

There is no doubt that the public is becoming less tolerant of costly corporate shenanigans, and that some executives now face the prospect of serving serious prison time for their wrongdoing. Thus, we can say that there has been some progress in making our criminal justice system fairer, in making punishments fit crimes and crimes fit harms, and in reducing the gap between the iron hand that poor street criminals have always encountered in the system and the velvet glove treatment which corporate bigwigs have commonly received. But the jury is not in on how far this gap has been reduced, and the signs are not good. 

One Wall Street executive commented that “the corporate sector was healing itself in the Betty Ford clinic for balance-sheet rehabilitation.”[37] Notice his emphasis on the whole ‘sector’ – and, in contrast with Terry, the executives could afford the private drug clinic. Indeed, they seem to have come out of rehab with a pay increase: “Despite last year’s loud cries for pay reform, Fortune 500 CEOs made more money than ever in 2003,” declares Fortune. The 2003 pay is higher than 2002, when “the average pay U.S. CEO earned 282 times what the average worker did…in 1982 the ratio was 42 to one.”[38] 

While the Martha Stewart case may get more TV time than those involving giant corporations like Enron or J.P. Morgan Chase, cases like the latter deal with the top executives at companies where the financial fraud was the greatest (and thus had the most victims). Although Stewart’s problems started with possible insider trading, her conviction was for obstructing the investigation into the insider trading – four counts, compared to 109 for Fastow. Critical thinking students of criminal justice in America must now watch the prosecutions for the recent frauds unfold, especially among those who held posts similar to Fastow or higher at companies that had fraudulent bookkeeping. Keep an eye on who gets charged, who gets sentenced, and then—later, when the memories of Enron and its like have faded—on how much of their sentences they actually serve? Likewise, we must watch to see if Congress maintains the integrity of the reforms or quietly relaxes them after a sufficient amount of campaign contributions. Will all the wrongdoers be charged and tried and punished? Will the convicted ones serve the full sentences that they received? Will laws to restrain predatory business practices be enforced, or will they be watered down once the public’s attention is elsewhere? In the past, after a flurry of headline grabbing activity, the system has gone back to business as usual. Will this happen again?

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Back to TALE OF TWO CRIMINALS

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Afterword, by Paul

The recent news is that Securities and Exchange Commission Chairman Donaldson is stepping down, and President Bush will nominate Congressman Cox to take over. Donaldson is seen as having been aggressive in regulating the industry he came from to help restore investor confidence. He seem to have been fairly independent, and 

William H. Donaldson says his biggest eye-opener since becoming chairman of the Securities and Exchange Commission 12 weeks ago is how much wrongdoing he's privy to see as the nation's top regulator of the securities industry. "I am surprised at how prevalent it is in the economy," he said yesterday. "I'm surprised at the day-in and day-out, steady level of malfeasance that comes in under the radar." New Strength At the SEC's Helm: Donaldson Surprises Consumer Advocates By Kathleen Day and Carrie Johnson (Washington Post 7 May 7, 2003; Page E01)

After Ken Lay & Jeff Skilling are convicted, Lay dies. His criminal conviction is erased, and so are the fines and forfeiture that are based on those criminal charges. We'll have to see what happens with Skilling's sentence and appeal. 

In a burst of rationality, the court upheld a 25 years sentence for Bernard Ebbers, CEO of Worldcom (aka Worldcon), which displaced Enron as the largest corporate bankruptcy in history. Many thought this sentence was irrational and execessive. I wrote in my blog: Ebbers' 25 Year Sentence for Worldcom Fraud Upheld. Good.