Among the hallmarks of a really good law review article for me are, first, when an article inspires me to have a storm of fresh thoughts about a given topic and, second, just as I think of an objection I then find that the author deals with the question on the very next page. Urska Velikonja’s piece meets both criteria. This paper is ambitious and engages a difficult subject of securities fraud deterrence. With all the moving parts in the legal system for deterring fraud, it is difficult to write a focused, cogent piece of scholarship and balance the need to be comprehensive without getting pulled in too many directions. Velikonja should be commended for it; she engages a number of the big fish in this particular pond yet manages to add many fresh ideas.
My main wish would be that Velikonja spend more time on the crux of her diagnosis of the problem and her proposal. One key element of Velikonja’s thesis is that individual culprits are under-deterred because management can protect itself by refusing to share information with enforcers (whether the SEC or private plaintiffs) about who was really responsible for an act of accounting fraud. We could spend a lot of time analyzing whether under-deterrence is a problem, but to keep my comments focused, I will assume it is real.
A more focused question is: what causes it? I’d like to read a little more about the scope of this particular problem of information sharing. Is information not being shared with enforcers via the discovery process? My brief and limited experience in practice with SEC enforcement actions suggested that the information requested and provided can be quite comprehensive. What information is being withheld on a systemic basis? The paper briefly touches on the ability of firms to stonewall with broad assertions of attorney-client privilege and work-product (p. 30, citing Sam Buell’s work). This could be fleshed out more, since ultimately information-forcing is a central rationale behind the paper’s proposal of leveraged sanctions.
One means of answering this question of what information is missing would be to speak with prosecutors and practitioners off-the-record to get a nuanced understanding of the games being played and the scope of information that might be missing. It may not be citable empirical research, but might let us know where to look for additional proof. (It might add some valuable practical insights to a fascinating theoretical piece, and help the author’s ideas gain policy traction.)
This same question of “what is the missing information” reappears in the details of the regime Velikonja proposes. Under the proposal, firms could reduce their liability, by cooperating with enforcers (p. 41). I would like to hear more about what would qualify as “cooperation.” To what extent are “internal accounting documents, memoranda, e-mails or other messages, and minutes of meetings” already being provided in discovery? If privilege is the central problem, is waiver of privilege the central part of the solution? There are a host of potential concerns with creating incentives for/coercing a waiver of privilege that recall the debates about the SEC attorney conduct rules several years ago. (For example, would pressure to waive privilege undermine close, trusting lawyer/client relationships and discourage clients from seeking counsel that would otherwise further compliance with the law?)
Velikonja’s proposal also brings to mind the debate seven years ago in the wake of the much-debated Thompson Memo, in which a Deputy Attorney General set forth guidelines for federal prosecutors to weigh cooperation from a corporation in making decisions to prosecute. The literature in the wake of that memo, although dominated by practitioners, has direct bearing on this paper. (As an aside, it would be interesting to re-examine (a) whether the Thompson Memo had any effect on prosecutor behavior, and (b) whether corporate cooperation changed).
Should cooperation be enough to release a firm completely from liability? Velikonja addresses the problem of whether innocent individuals may scapegoated, but I wonder even if the firm provided more information, might we still have under-deterrence of individuals. The probability of a prosecutor bringing a successful case against individuals even with full disclosure from a firm may be quite low for any number of other reasons. Just a few examples: the enforcer might be able to prove all of the elements of a case, just not for any one person. It may also prove harder to get a jury verdict against a person with pictures of kids in her/his wallet than against a corporation with no soul to damn or body to kick. If under-deterrence of individuals is the problem, is lack of cooperation from firms the main cause?
On the other hand, firms may rightly worry about a loose definition of “cooperation” leading to ratcheting by the government. If we are unsure if lack of cooperation is the dominant cause of under-deterrence or if we are concerned with how to define cooperation, the proposal might instead condition a liability release for the firm on a verdict or settlement against individuals. (I assume that the proposal would also have to constrict indemnification for individual settlements if not insurance). The problem with this alternative is that it might create too strong an incentive to scapegoat (a problem, my fellow commentator, Professor Krawiec, has written about). Calibrating the trigger for release of leveraged sanctions seems extremely tricky.
Then there is the question of calibrating the size and nature (civil, criminal) of the leveraged sanction. Would the sanction on the firm be larger than the liability an individual would face? Trying to work out the size of the sanction in more detail may be too much to add to this paper, and Velikonja makes the wise decision to frame the question in terms of comparing alternative solutions rather than talking about optimal deterrence. However, I am not yet convinced that these calibration problems with leveraged sanctions are easier to solve than the calibration problem Velikonja identifies with an alternative solution – namely better design of executive compensation.
Velikonja considers over-deterrence (p. 47), but I’d like to read just a little bit more on this too. Management and employees will still need to exercise judgment in divining the line between “aggressive accounting” and fraud. How careful should they be? Velikonja writes “…there is no social value in aggressive accounting.” (p. 48) To play devil’s advocate, where is the dividing line between aggressive accounting and a valid exercise of discretion among different options to reflect the financial results of the firm more accurately? Courts answer this problem all the time, but the challenge still remains for firms and employees in day-to-day decisions on accounting. Again, better designed compensation, orienting it towards long term firm performance, may be easier to resolve than this question of over-deterrence.
These comments shouldn’t be construed to mean the paper should have focused on executive compensation or some other solution to the problem of accounting fraud. Quite the contrary: this author, her ideas and her proposal are so engaging and stand out so much in a crowded field, that I would like to hear more of her.
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