As Enron CEO Jeffrey Skilling’s appeal comes under scrutiny, and the flames of passion have died down, a different view is emerging toward “corporate criminals.” Maybe, just maybe, they aren’t exactly criminals, but businesspeople who did a lousy job and made some bad decisions.
In a great article, Criminalizing Capitalism, Nicole Gelinas dissects why the efforts to prevent these corporate criminals from ever taking over again has resulted in the next great failure, the subprime mortgage crisis, and will continue to fail.
It wasn’t supposed to be this way. After Enron imploded six years ago, Congress and President Bush enacted the Sarbanes-Oxley law, which aimed to reform corporate practices and prevent future market surprises. The law imposed new regulations on corporations and their executives, as well as new criminal sanctions for corporate wrongdoing under both the new law and existing ones. “How can you measure the value of knowing that company books are sounder than they were before?” asked sponsor Michael Oxley, defending the law. “Of no more overnight bankruptcies with the employees and retirees left holding the bag? No more disruption to entire sectors of the economy?”
But in the end, Sarbanes-Oxley has just made it easier for ambitious government attorneys to criminalize bad business judgment and complex accounting in hindsight. Further, in their focus on strengthening legal enforcement, the feds have passed up opportunities to create commonsense protections for investors. Worse still, the government has instilled investors with false confidence by implying that they can rely on prosecutors, not prudence, to protect their market holdings. Now the housing and mortgage meltdown—which could hurt the economy far more than Enron did—is reminding investors that no law or regulation can protect them from economic disruption.
According to common wisdom, Enron’s crash had to reflect criminal conduct. It was impossible for so much harm to be cause otherwise. Or so it seemed.
Enron was actually an example of how markets work—messily, sometimes tardily, but in the end with ruthless efficiency.
In the year before the crash, Enron stock lost half its value on Wall Street.
When Enron declared bankruptcy in December 2001, the regulators were left only to certify the market’s verdict. Those investors and lenders who hadn’t scrutinized the company lost money, as they should have
In other words, it was a business failure, available for all to see if they cared to look.
Though Enron didn’t signal a market failure, it was a business failure, of course. The company overvalued its assets while undervaluing its liabilities—the oldest trick in the fraud book but also sometimes an honest mistake. In the 1930s, Samuel Insult, a utility entrepreneur who created the modern power grid, did the same thing; so did savings and loan banks in the 1980s. Enron’s chief financial officer, Andy Fastow, did it by vastly overstating the company’s assets and hiding liabilities, such as off-the-books sums owed to outside “investment partnerships” (he stole cash on the side, too). It was easy for Enron to perform accounting hocus-pocus because many of its assets, such as a one-of-a-kind power plant in India and speculative broadband ventures, were difficult to value. Enron’s assets were worth what Enron said they were—until the market decided otherwise.
Young prosecutors, armed with laws like SOX that criminalize bad calls unless outsiders are equally inept in approving the bad calls, view big business as an exact science. It’s not entirely their fault, since business likes to pretend that it has a clue what it’s doing, rather than the very overpriced mom and pop shop run by the fortunate son who thinks his every whim is a stroke of capitalist brilliance. This is bolstered by a cadre of Wall Street jargoneers, who similarly pretend that they have a clue.
Wall Street prosecutions weren’t born with Sarbanes-Oxley. As prominent white-collar defense attorney Stan Arkin says, prestigious law firms regarded criminal-defense practices as unsavory 40 years ago, but the increased threat of white-collar prosecutions eventually led almost all of them to offer such services. Many in the financial world first understood the acute risks in the 1980s, when Rudy Giuliani—then the U.S. attorney for the Southern District of New York, which includes Wall Street—ordered three investment bankers arrested in their offices or homes, one of them in handcuffs, on suspicion of insider trading, though two of the three cases against them were later dropped
And so, under the ever-watchful eye of our savior, St. Rudy of the TV Cameras (and now an important criminal defense lawyer), the spectacle of white collar crime became the solution to the vagaries of business.
After discussing the advantages that the law and courts have given prosecutors in “white collar prosecutions,” because of the perceived complexities of unearthing evidence and understanding how businesses engage in their “conspiracies” (better known as board meetings), Gelinas writes:
Contrary to popular perception and despite millions of documents, the feds had no smoking-gun evidence against Enron chiefs Jeff Skilling and Ken Lay. The two men, each of whom served as CEO at times during the company’s final two years, faced charges that included conspiring to conceal Enron’s true financial state before it collapsed and, in Skilling’s case, selling company shares using information about that conspiracy.
But in court, any complex accounting is suspect. “They were accountants,” said juror Freddy Delgado of some witnesses. “They mumbled, and I didn’t know anything about what they talked about.” Further, prosecutors pressed companies and people to cooperate who might otherwise have cleared up what Skilling and Lay knew about that accounting. Banks like CIBC and Merrill Lynch, which participated in Enron’s financing, reached deals with the government that kept employees from testifying for the defense.
And so, a new field of crime was born and came to maturity. The crime, of course, was pretending that these men at the top of the corporate food chain knew what they were doing, when the truth was that they were treading water as hard as they could to make it seem that they had everything under control. They did this to satisfy the Wall Street analysts, who were similarly pretending that they understood what was going on with the company, to pretend that they could offer some intelligent assessment when they got a spot on the morning cable business report with the Money Honey.
But the truth could be found in the jury room:
After the trial, it became clear that some jurors didn’t even understand what they had convicted the two defendants of doing. Describing how he had reached the guilty verdict, Delgado said: “To say you didn’t know what was going on in your own company was not the right thing.” Another juror, Dana Fernandez, said that if Lay and Skilling “didn’t know, they should have found out somehow what was going on.” But the burden of the government’s case was to prove beyond reasonable doubt that Lay and Skilling had engineered a conspiratorial fraud. If they didn’t know about the conspiracy—regardless of whether they should have known about it—the jury should have found them not guilty.
A guilty verdict, but the truth is that no one in the courtroom really had any understanding of what was done and why it was criminal. They understood that it didn’t work, and that seemed to be a bad thing, even something that made the defendants prison-worthy, but they couldn’t tell you why. That, in a nutshell, is the sad secret of white collar crime.
The worst thing about criminalizing what should often be civil regulatory matters is that it creates a false sense of security for investors, who may think that aggressive prosecutions protect them from losses. Disclosure—even if it’s slow and imperfect—is still their best protection. “We find little evidence that public enforcement benefits stock markets, but strong evidence that laws mandating disclosure and facilitating private enforcement through liability rules benefit stock markets,” observed Dartmouth business professor Rafael La Porta, University of Amsterdam professor Florencio Lopez-de-Silanes, and Harvard professor Andrei Shleifer in a recent Journal of Finance study.
And this is what it’s all about, from SOX to prosecutions. Giving the investing public a sense of false security that when things go horribly wrong, it’s because of criminals and not just lousy business people making bad decisions with other people’s money.
Every time our economy faces another disaster, heads will necessarily roll and prosecutors profiles will rise as the heroes of the great unwashed. We want so badly to believe that business really knows what it’s doing, that Wall Street isn’t a total scam, that we can invest our money in the American economy and still sleep at night, unless those mean criminals take hold of it.
There are people in business who commit crimes. Who lie and defraud. But there are far more who just aren’t anywhere near as good at what they do as they claim, and they go down foolish roads and make bad decisions and stand there at the helm of their corporation as it crashes against the rocks. There isn’t always a criminal to blame. Some of our most celebrated business minds are just a bunch of lucky folks who managed to skirt disaster by making a zig rather than a zag at the right moment. If you catch them with a few martinis in them, they might even tell you that they didn’t have a clue why they picked that path. It just seemed like a good idea at the time.
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