My previous blogposts (one, two, three, four, five, six, seven, and eight) discussed the dangers of granting intracorporate conspiracy immunity to agents who commit coordinated wrongdoing within an organization. The last two blogposts (here and here) highlighted the harm that public and judicial frustration with this immunity inflicts on alternative doctrines.
In addition to exacerbating blind CEO turnover, substituting alternative doctrines for prosecuting intracorporate conspiracy affects an executive’s incentives under Director’s and Officer’s (D&O) liability insurance. This post builds on arguments that I have made about D&O insurance in articles here and here.
In traditional conspiracy prosecutions, the Model Penal Code (MPC) provides an affirmative defense for renunciation. The MPC’s standard protects the actor, who “after conspiring to commit a crime, thwarted the success of the conspiracy, under circumstances manifesting a complete and voluntary renunciation of his criminal purpose.” This means that the executive who renounces an intracorporate conspiracy faces no charges.
In contrast with conspiracy prosecutions, responsible corporate officer doctrine and its correlates fail to reward the executive who changes course to mitigate damages or to abandon further destructive behavior. Although the size of the damages may be smaller with lesser harm if the executive renounces an organization’s course of conduct, the executive’s personal career and reputation may still be destroyed by entry of a judgment. Modest whistle-blower protections are ineffectual.
Specifically, because of the way that indemnification and D&O insurance function, the entry of judgment has become an all-or-nothing standard: an employee’s right to indemnification hinges on whether the employee is found guilty of a crime or not. To receive indemnification under Delaware law, for example, an individual must have been “successful on the merits or otherwise in defense of any action, suit or proceeding.” Indemnification is repayment to the employee from the company; D&O insurance is a method that companies use to pass on the cost of indemnification and may contain different terms than indemnification itself.
Indemnification and D&O insurance are not a minor issues for executives. In fact, under many circumstances, employees have a right to indemnification from an organization even when the alleged conduct is criminal. Courts have acknowleged that “[i]ndemnification encourages corporate service by capable individuals by protecting their personal financial resources from depletion by the expenses they incur during an investigation or litigation that results by reason of that service.” And when hiring for an executive board, “Quality directors will not serve without D&O coverage.” Because of this pressure from executives, as many as ninety-nine percent of public U.S. companies carry D&O insurance.
So what does this standard mean for executives prosecuted under responsible corporate officer doctrine instead of for traditional conspiracy? Executives are incentivized either not to get caught, or to perpetrate a crime large enough that the monetary value of the wrongdoing outweighs the potential damage to the executive’s career. Because an executive’s right to indemnification hinges on whether he is found guilty of a crime or not, he has an enormous incentive to fight charges to the end instead of pleading to a lesser count. Thus, unless the executive has an affirmative defense to charges, like renunciation in traditional conspiracy law, there is no safety valve. Litigating responsible corporate officer doctrine cases creates a new volatile high-wire strategy. Moreover, as discussed in my last blogpost, responsible corporate officer doctrine imposes actual blind “respondeat superior” liability. Regardless of the merits, the executive may be penalized. So you can see the take-home message for executives: go ahead and help yourself to the largest possible slice pie on your way out the door.
I argue that in sending this message, and in many other ways, our current law on corporate crime is badly broken. My last blogpost for the Glom will introduce the book that Lynn Stout and I propose writing to give better direction to business people in search of ethical outcomes.
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My previous blogposts (one, two, three, four, five, six, and seven) discussed why conspiracy prosecutions were the best method to penalize coordinated wrongdoing by agents within an organization. Using alternative doctrines to impose liability on behavior that would otherwise be recognized as an intracorporate conspiracy results in flawed incentives and disproportionate awards.
The fundamental problem with substituting responsible corporate officer doctrine and control person liability for reforming the intracorporate conspiracy doctrine is that these alternative doctrines represent exactly what Professor Martin objects to: actual imposition of blind “respondeat superior” liability. For example, under these doctrines, “in most federal courts, it is not necessary to show that the corporate official being charged had a culpable state of mind.” Instead, the issue before the court is merely whether the officer had control and responsibility for the alleged actions. Accordingly, it is not a defense to control person liability that the officer did not “knowingly participate in or independently commit a violation of the Act.”
But simply penalizing the officer who is in the wrong place at the wrong time does little to define and encourage best practices. Moreover, with these and other explosive hazards for corporate service, it should be no surprise that top executives are demanding and receiving ever-increasing compensation for often short-term positions. Since 2009, the year that the NSP case establishing “control person” liability was settled, the discrepancy in pay between top management and the average worker has been growing dramatically. In 2013, the CEO of J.C. Penny Co., for example, was exposed for making 1,795 times what the average U.S. department store employee made. From 2009 to 2013, as measured across Standard & Poor’s 500 Index (S&P 500) of companies, “the average multiple of CEO compensation to that of rank-and-file workers” has risen to 204, an increase of twenty percent.
It is true that the financial crisis did reduce executive compensation packages before 2009, and that there has been a historical trend towards the growth of executives’ salaries as a multiple of average workers’ salaries. For example, “[es]timates by academics and trade-union groups put the number at 20-to-1 in the 1950s, rising to 42-to-1 in 1980 and 120-to-1 by 2000.” But the jump in executives’ salaries from 2009 has been extraordinary. The new emphasis on vicarious liability for individuals under the responsible corporate officer doctrine since that date must be considered part of executives’ demands for such high compensation in exchange for their risky positions.
The average duration of a CEO’s time in office has diminished as well. In 2000, the average tenure of a departing S&P 500 CEO in the U.S. was ten years. By 2010, it was down to eight years. In 2011, merely a year later, the average tenure of a Fortune 500 CEO was barely 4.6 years. In 2013, that former CEO of J.C. Penny Co. served for only eighteen months.
With an eighteen-month tenure, how much can the chief executive of a large company discover about the wrongdoing that his or her new company is committing? Furthermore, how much can that person design and institute good preventative measures to guide his or her subordinates to avoid that harm? A blindly revolving door for CEOs does not help those interested in effectively reducing the wrongdoing of agents within the corporation. Incentives without intracorporate conspiracy immunity would be different because they would reward the agent who abandons a conspiracy. (More about this argument here, here, here, and here.)
My next blogpost will examine how substituting alternative doctrines for prosecuting intracorporate conspiracy affects incentives under Director’s and Officer’s (D&O) liability insurance.
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My previous blogposts (one, two, three, four, five, and six) discussed why conspiracy prosecutions should be used to reach coordinated wrongdoing by agents within an organization. The intracorporate conspiracy doctrine has distorted agency law and inappropriately handicaps the ability of tort and criminal law to regulate the behavior of organizations and their agents.
My Intracorporate Conspiracy Trap article argues that the intracorporate conspiracy doctrine is not properly based in agency law, and that it should most certainly not be applied throughout tort law and criminal law. As a result of the immunity granted by the doctrine, harmful behavior is ordered and performed without consequences, and the victims of the behavior suffer without appropriate remedy. My Corporate Conspiracy Vacuum article argues that public and judicial frustration with the lack of accountability for corporate conspiracy has now warped the doctrines around it.
Courts have used a wide variety of doctrines to hold agents of enterprises responsible for their actions that should have prosecuted as intracorporate conspiracy. Some of these doctrines include:
But the new applications of these alternative doctrines are producing distortions that make the doctrines less stable, less predictable, and less able to signal proper incentives to individuals within organizations.
An example of how piercing the corporate veil has been used to defeat intracorporate conspiracy immunity can be seen in the Morelia case. A previous blogpost discussed how the intracorporate conspiracy doctrine has defanged RICO prosecutions of agents and business entities. In Morelia, which was a civil RICO case, the federal district court, obviously outraged by defendants’ behavior in the case, explicitly permitted plaintiffs to pierce the corporate veil to avoid application of the intracorporate conspiracy doctrine. In a creative twist invented from whole cloth to link the two doctrines, the Morelia court overruled its magistrate judge’s recommendation to announce:
"Since the court has determined that plaintiffs have properly alleged that the corporate veil should be pierced, the individual defendants may be liable for corporate actions and any distinction created by the intra-corporate doctrine does not exist."
Regarding its test for piercing the corporate veil, the Morelia court further overruled its magistrate’s recommendation by focusing on plaintiffs’ arguments regarding undercapitalization, and its decision included only a single footnote about the disregard of corporate formalities.
The Morelia court is not alone in its frustration with the intracorporate conspiracy doctrine and in its attempt to link analysis under the intracorporate conspiracy doctrine with the stronger equitable tenets of piercing the corporate veil. More subtly, courts across the country have started to entangle the two doctrines’ requirements as intracorporate conspiracy immunity has become stronger and courts have increasingly had to rely on piercing the corporate veil as an ill-fitting alternative to permit conspiracy claims to proceed. Even large public companies should take note. No public company has ever been pierced, but a bankruptcy court recently reverse-pierced corporate veils of the Roman Catholic Church, which is far from a single-person “sham” corporation. My Corporate Conspiracy Vacuum article discusses additional examples and repercussions for incentives under each of these alternative doctrines.
My next blogpost will examine how frustration with intracorporate conspiracy immunity has led to volatility in responsible corporate officer doctrine and related control person liability. Ironically, executive immunity from conspiracy charges fuels counterproductive CEO turnover.
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My previous blogposts (one, two, three, four, and five) introduced why conspiracy prosecutions should be used to reach wrongdoing by agents within an organization. The 2012 prosecution of Monsignor Lynn for twelve years of transferring predator priests from parish to parish at the command and for the benefit of the Archdiocese of Philadelphia was defeated by the intracorporate conspiracy doctrine. Moreover, this was not the first time that the Roman Catholic Church had used the doctrine to help its bureaucrats escape liability for suppressing sex abuse cases.
In 1997, employees of the Roman Catholic Church in Connecticut were alleged—very much like Lynn—to have covered up the sexual misconduct of a priest, enabling him to continue to abuse children entrusted to the Church’s care by virtue of his office. When sued for civil conspiracy by the victims, the employees’ defense was that they were acting in the best interest of the corporation.
The Connecticut court found that the test for whether an agent is acting within the scope of his duties “is not the wrongful nature of the conspirators’ action but whether the wrongful conduct was performed within the scope of the conspirators’ official duties.” If the wrongful conduct was performed within the scope of the conspirators’ official duties, the effect of applying the intracorporate conspiracy doctrine is to find that there was no conspiracy. Because covering up the priest’s sex abuse was in the best interest of the corporate organization, the court found that the employees were all acting on behalf of the corporation. The court never reached the issue of whether the employees’ actions rose to the level of a civil conspiracy. Under the intracorporate conspiracy doctrine, it was a tautology that no conspiracy could be possible.
This case is interesting not only because it documents the way that the intracorporate conspiracy doctrine protects enterprises from inquiry into conspiracies, but also because of the subsequent history of its allegations. The full extent of the Bridgeport Diocese’s wrongdoings—if current public knowledge is indeed complete—only came to light in December 2009, twelve years after the 1997 case. It took twelve years, the combined resources of four major newspapers, an act displaying public condemnation of the Roman Catholic Church by members of the state legislature, and finally a decision by the U.S. Supreme Court to release the documents that could have become the basis of the intracorporate conspiracy claim in 1997. There is still no conspiracy suit or any criminal charge against the Diocese. Additional details about the case are available in my article The Intracorporate Conspiracy Trap. The article will be published soon in the Cardozo Law Review, and it is available in draft form here.
Astonishingly, none of the extensive news coverage about the sexual abuse cases in Bridgeport over those additional twelve years has connected these facts to the original 1997 case defeated by application of the intracorporate conspiracy doctrine. If the intracorporate conspiracy doctrine had not provided immunity, the case might have revealed the Diocese’s pattern of wrongdoing long beforehand and in a much more efficient way.
My next blogpost reveals additional dangers from the spread of the intracorporate conspiracy doctrine: frustration with the intracorporate conspiracy doctrine has started to distort other areas of law.
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My previous blogposts (one, two, three, and four) introduced why conspiracy prosecutions should be used to reach wrongdoing by agents within a business organization. The same legal analysis applies to religious organizations.
We should have been able to charge Monsignor Lynn and the Archdiocese of Philadelphia that directed his actions to hide the sexual abuse by priests with criminal conspiracy. Instead, Pennsylvania charged Lynn with two things: child endangerment and conspiracy with the priests.
As international news outlets later reported, Lynn could not be guilty of child endangerment because the state’s statute could not apply to an administrative church official who did not directly supervise children.
Lynn could not be guilty of conspiracy with the priests because he did not share their “particular criminal intent.” As the jury understood, Lynn was not trying to help a predator priest get from parish to parish so that “he can continue to enjoy what he likes to do.” Lynn was trying to protect the reputation of his employer, the Archdiocese—if the priests benefitted, that was a side issue.
So why didn’t the prosecution charge Lynn and the Archdiocese with conspiracy? It was the Archdiocese that directly coordinated and profited from Lynn’s actions. The intracorporate conspiracy doctrine, as discussed before, would bar that prosecution. In Pennsylvania, it is “well-settled that a corporation cannot conspire with its subsidiary, its agents, or its employees.”
Finally, considering other options, Lynn could not have been charged with possible crimes such as obstruction of justice. Lynn was too good: Lynn and the Archdiocese were so successful at covering up the sexual abuse and silencing victims, there was no ongoing investigation to obstruct. “Aiding and abetting” the Archdiocese’s cover-up of the sex abuse would have been difficult to pursue (see more here) and is not allowed under RICO in the Third Circuit.
My next blogpost will demonstrate that the Monsignor Lynn case was also part of a pattern by the Roman Catholic Church in America to use the intracorporate conspiracy doctrine to hide the coordinated wrongdoing of its agents to cover-up sexual abuse by priests. Fifteen years before prosecutors attempted to try Monsignor Lynn, the silenced Connecticut sex-abuse case showed the Church how effective this defense could be.
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My previous blogposts (one, two, and three) introduced the topic of how the intracorporate conspiracy doctrine prevents the prosecution of coordinated wrongdoing by individuals within organizations. This post illustrates the doctrine’s effect in the context of a specific organization—here a religious one: the Roman Catholic Archdiocese of Philadelphia and the systematic transfer of predator priests. This post is based on my article The Intracorporate Conspiracy Trap to be published soon in the Cardozo Law Review. The article is available in draft form here.
For twelve years, from 1992 to 2004, as Secretary for Clergy, Monsignor William Lynn’s job within the Philadelphia Archdiocese was to supervise priests, including the investigation of sex-abuse claims. In 1994, Monsignor Lynn compiled a list of thirty-five “predator” priests within the archdiocese. He compiled the list from secret church files containing hundreds of child sex-abuse complaints. On the stand, Lynn testified that he hoped that the list would help his superiors to address the growing sex-abuse crisis within the Archdiocese. But for twelve years Lynn merely re-assigned suspected priests, and he hid the abuse within the church. His superiors never acted on the list that Lynn gave them—in fact, they ordered all copies of the list destroyed—and Lynn never contacted outside authorities. As late as 2012, one of the “predator” priests on Lynn’s list was still serving in a parish.
All parties agree that Lynn’s actions in transferring priests who molested children allowed those priests to continue to abuse children, sheltered the priests from potential prosecution, and directly protected the Philadelphia Archdiocese’s reputation.
In fact, Lynn’s actions had been ordered by the archbishop on behalf of the Archdiocese. Lynn reported what he was doing to his superiors, who rewarded Lynn with twelve years of employment and a prominent position within the Archdiocese for doing his job as they saw it. Moreover, the archbishop himself inadvertently revealed the existence of the number thirty-five “predator” priests to the media, and he was the one who ordered all copies of the list to be shredded to keep it from being discovered in legal proceedings.
The instinct here is that this behavior—the transferring of predator priests to cover-up the sexual abuse of children—should have been illegal for Monsignor Lynn to pursue. But the Commonwealth could not prosecute Monsignor Lynn and the Archdiocese for conspiracy. Furthermore, immunity for Lynn’s behavior is now the rule in most state and federal jurisdictions around the country. As described in an earlier blogpost, the intracorporate conspiracy doctrine provides immunity to an enterprise and its agents from conspiracy prosecution, based on the legal fiction that an enterprise and its agents are a single actor incapable of the meeting of two minds to form a conspiracy.
My next blogpost will further investigate why this behavior was not illegal under our current system, and how we should have tried Monsignor Lynn.
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My first and second blogposts introduced why conspiracy prosecutions are particularly important for reaching the coordinated actions of individuals when the elements of wrong-doing may be delegated among members of the group.
So where are the prosecutions for corporate conspiracy??? The Racketeer Influenced and Corrupt Organizations Act of 1970 (“RICO”, 18 U.S.C.A. §§ 1961 et seq.), no longer applies to most business organizations and their employees. In fact, business organizations working together with outside agents can form new protected “enterprises.”
What’s going on here? In this area and many other parts of the law, we are witnessing the power of the intracorporate conspiracy doctrine. This doctrine provides immunity to an enterprise and its agents from conspiracy prosecution, based on the legal fiction that an enterprise and its agents are a single actor incapable of the meeting of two minds to form a conspiracy. According to the most recent American Law Reports survey, the doctrine “applies to corporations generally, including religious corporations and municipal corporations and other governmental bodies. The doctrine applies to all levels of corporate employees, including a corporation’s officers and directors and owners who are individuals.” Moreover, it now extends from antitrust throughout tort and criminal law.
What is the practical effect of this doctrine? The intracorporate conspiracy doctrine has distorted agency law and inappropriately handicaps the ability of tort and criminal law to regulate the behavior of organizations and their agents. Obedience to a principal (up to a point) should be rewarded in agency law. But the law should not immunize an agent who acts in the best interest of her employer to commit wrongdoing. Not only does the intracorporate conspiracy doctrine immunize such wrongdoing, but the more closely that an employer orders and supervises the employee’s illegal acts, the more the employer is protected from prosecution as well.
My next blogpost illustrates how the intracorporate conspiracy doctrine operates to defeat prosecutions for coordinated wrongdoing by agents within an organization. Let’s examine the case of Monsignor Lynn.
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In my previous blogpost, I granted the merit of defense counsel’s argument that the actions of discrete individual defendants—when the law is not permitted to consider the coordination of those actions—may not satisfy the elements of a prosecutable crime.
But what is the coordination of individuals for a wrongful common purpose? That’s a conspiracy. And, for exactly the reasons that defense counsel articulates, these types of crimes cannot be reached by other forms of prosecution. The U.S. Supreme Court has recognized that conspiracy is its own animal. “[C]ollective criminal agreement—partnership in crime—presents a greater potential threat to the public than individual delicts.” When we consider the degree of coordination necessary to create the financial crisis, we are not talking about a single-defendant mugging in a back alley—we are talking about at least the multi-defendant sophistication of a bank robbery.
Conspiracy prosecutions for the financial crisis have some other important features. First, the statute of limitations would run from the last action of a member of the group, not the first action as would be typical of other prosecutions. This means that many crimes from the financial crisis could still be prosecuted (answering Judge Rakoff’s concern). Second, until whistle-blower protections are improved to the point that employees with conscientious objections to processes can be heard, traditional conspiracy law provides an affirmative defense to individuals who renounce the group conspiracy. By contrast, the lesson Wall Street seems to have learned from the J.P. Morgan case is not to allow employees to put objections into writing. Third, counter to objections that conspiracy prosecutions may be too similar to vicarious liability, prosecutors would have to prove that each member of the conspiracy did share the same common intent to commit wrongdoing. The employee shaking his head “no” while saying yes would not be a willing participant, but many other bankers were freely motivated by profit at the expense of client interest to cooperate with a bank’s program.
My next blogpost will ask: where are the prosecutions for corporate conspiracy?
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It is a pleasure to be guest-blogging here at The Glom for the next two weeks. My name is Josephine Nelson, and I am an advisor for the Center for Entrepreneurial Studies at Stanford’s business school. Coming from a business school, I focus on practical applications at the intersection of corporate law and criminal law. I am interested in how legal rules affect ethical decisions within business organizations. Many thanks to Dave Zaring, Gordon Smith, and the other members of The Glom for allowing me to share some work that I have been doing. For easy reading, my posts will deliberately be short and cumulative.
In this blogpost, I raise the question of what is broken in our system of rules and enforcement that allows employees within business organizations to escape prosecution for ethical misconduct.
Public frustration with the ability of white-collar criminals to escape prosecution has been boiling over. Judge Rakoff of the S.D.N.Y. penned an unusual public op-ed in which he objected that “not a single high-level executive has been successfully prosecuted in connection with the recent financial crisis.” Professor Garett’s new book documents that, between 2001 and 2012, the U.S. Department of Justice (DOJ) failed to charge any individuals at all for crimes in sixty-five percent of the 255 cases it prosecuted.
Meanwhile, the typical debate over why white-collar criminals are treated so differently than other criminal suspects misses an important dimension to this problem. Yes, the law should provide more support for whistle-blowers. Yes, we should put more resources towards regulation. But also, white-collar defense counsel makes an excellent point that there were no convictions of bankers in the financial crisis for good reason: Prosecutors have been under public pressure to bring cases against executives, but those executives must have individually committed crimes that rise to the level of a triable case.
And why don’t the actions of executives at Bank of America, Citigroup, and J.P. Morgan meet the definition of triable crimes? Let’s look at Alayne Fleischmann’s experience at J.P. Morgan. Fleischmann is the so-called “$9 Billion Witness,” the woman whose testimony was so incriminating that J.P. Morgan paid one of the largest fines in U.S. history to keep her from talking. Fleischmann, a former quality-control officer, describes a process of intimidation to approve poor-quality loans within the bank that included an “edict against e-mails, the sabotaging of the diligence process,… bullying, [and] written warnings that were ignored.” At one point, the pressure from superiors became so ridiculous that a diligence officer caved to a sales executive to approve a batch of loans while shaking his head “no” even while saying yes.
None of those actions in the workplace sounds good, but are they triable crimes??? The selling of mislabeled securities is a crime, but notice how many steps a single person would have to take to reach that standard. Could a prosecutor prove that a single manager had mislabeled those securities, bundled them together, and resold them? Management at the bank delegated onto other people elements of what would have to be proven for a crime to have taken place. So, although cumulatively a crime took place, it may be true that no single executive at the bank committed a triable crime.
How should the incentives have been different? My next blogpost will suggest the return of a traditional solution to penalizing coordinated crimes: conspiracy prosecutions for the financial crisis.
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The guilty verdict for Virginia ex-governor Bob McDonnell on charges of public corruption is a major headline of today. I've been thinking a lot about corruption for the past few months, so here are a few thoughts:
-Corruption is in the eye of the beholder. My Essay turns on the proximity of time of two donations and legislative action. In the most notable case, a member of the House introduced a bill the day after receiving a $1000 donation. Readers' reactions to the story fall into two distinct camps. One: OMG! I can't believe that! Two: So what? Why does that necessarily mean there's corruption? In answer I say:
-Timing does matter. From the WaPo:
[Prosecutors] backed up his story by using other evidence to weave a strong circumstantial case that an agreement had been reached between the businessman and the first couple based on the close timing of Williams’s gifts and loans and efforts by the McDonnells to assist Williams and his company.
In one instance, McDonnell directed a subordinate to meet with Williams on the same night he returned from a free vacation at his lake house. In another, six minutes after e-mailing Williams about a loan, McDonnell e-mailed an aide about studies Williams wanted conducted on his product at public universities.
-definitions are the name of the game. The Supreme Court's 2014 McCutcheon decision narrowed the definition of corruption to only cases of quid pro quo corruption--cases where there's an actual exchange. The McDonnell defense apparently conceded that there was an exchange, but contested whether the quo in question--events at the governor's mansion, setting up meetings for the donor--counted as "official acts." This is a broad definition.
-Corporations are always going to participate in political life. We expect them to lobby for positions favorable to their firms. See here for a recent WSJ article on disclosure of political spending, with quotations from some sterling law professors, including friends-of-Glom Mike Guttentag and Steve Bainbridge, who quite rightly observes that the risk is that managers spend the corporation's money "on their own preferences, as opposed to what's good for the company."
-So in corporate governance terms the question is how to sort the "good" spending that is for the benefit of the company from the "bad" spending that is driven by idiosyncratic managerial preference and doesn't do the corporation any good. But in political governance terms, the question is how to regulate even "good" corporate spending that we find to be corrupting. I at least don't have a good idea of how to draw that line. The Court says trading donations for access is fine, and so are donations that secure a candidate's gratitude. My hunch is a lot of people might call those corruption. But corporations need to be able to explain to candidates how the government's rules and regulations affect their business. I'm certainly not confident that the average politician knows much of anything about any particular issue.
So where does that leave me? Still wondering about corruption, and eager to get back to corporate and securities law, that's where!
I wanted to finish up my discussion of administrative enforcement by considering alternatives. We often take regulatory enforcement for granted. A securities regulator, for example, naturally will have the power to seek out violations of the securities laws and sanction violations. As is common in administrative law, scholars, courts, and Congress start with the assumption that expertise in the industry is the most important input into the enforcement calculus. If an agency is familiar with an industry, it will make good enforcement choices.
In my forthcoming article in the Minnesota Law Review, I argue that this question is actually much more complex than we usually assume. In particular, prosecutorial discretion has strong generalist aspects that largely do not depend on the regulatory subject matter. Giving enforcement authority to a specialist agency instead of a generalist enforcer (such as the Department of Justice) trades one type of expertise for another. Furthermore, specialists inherently see enforcement actions more narrowly. As a result, we shouldn’t see enforcement by regulatory agencies as inevitable or automatic.
Since it is still in draft form, I’d very much appreciate any and all comments. Thanks again to Erik for the chance to blog this week.
I blogged yesterday about administrative enforcement, an area that lies at the intersection of criminal and administrative law. Among other topics, my scholarship has considered the civil penalty process. In particular, what are the inputs and incentives that shape administrative agency penalties?
A standard model used to describe the penalty process emphasizes economic theories of deterrence. Financial penalties are a mechanism to raise the price for violations either to make misconduct completely unprofitable or, in the alternative, to force violators to internalize the costs of violations. I’ve pointed out one way that this theory may break down – administrative agencies might not focus on deterrence at all. Instead, their penalties may be crafted to achieve retributive ends.
In our recent Harvard Law Review article, For-Profit Public Enforcement, Margaret H. Lemos and I looked at penalties from another perspective: public enforcers may have self-interested reasons to maximize civil penalty recoveries. These incentives are widely recognized in private enforcement. Class action lawyers, for example, operating on a contingency fee basis have straightforward reasons to maximize recoveries.
Perhaps less obviously, public enforcement lawyers can have comparable incentives to impose large penalties. These incentives work most clearly in cases where enforcement agencies keep a portion of the civil penalties imposed. This structure is common in the asset forfeiture process used in connection with many criminal cases and also exists in other state and federal enforcement contexts. Even when penalties are turned over to the general treasury, enforcers may have reputational incentives to maximize penalties. Both agencies as a whole and individuals working in enforcement agencies may seek to build a reputation as an aggressive enforcer for reasons other than deterrence.
Assuming that these claims are right and that civil penalties can be driven by retributive or self-interested goals, is this a problem? Perhaps, perhaps not. Self-interested public enforcement may push enforcers to emphasize financial recoveries over other tools of regulatory control, such as injunctive relief. However, if our default assumption is that administrative agencies underenforce and usually do not impose adequate penalties, the pressure of self-interest may correct this trend to some degree.
The presence of retribution in civil penalties has similarly mixed effects. Of course, if penalties are supposed to be carefully calculated to deter, retributive ends will hamper this goal. On the other end, we now widely recognize the role of norms in shaping compliance behavior. Retributive punishment done well can shape and reinforce industry norms.
Erik, thank you for that introduction. It is a pleasure to join the Conglomerate for a week. My scholarly interests have recently focused on federal administrative enforcement – enforcement actions by agencies like the SEC, the CFTC, as well as a host of lower profile entities. This is a fascinating area of public law combining two scholarly literatures. Administrative enforcement actions share much in common with criminal cases. They are brought by public entities to vindicate public wrongs. However, the administrative context deeply shapes this type of enforcement. For example, unlike most prosecutor's offices, administrative enforcement bodies tend to be industry-specific.
As a result, administrative enforcement can go wrong in two different ways– the “criminal law” way or the “administrative law” way. Administrative agencies face the challenges of regulatory capture, inadequate or incorrect information, or simply the wrong incentives to engage in appropriate regulatory action. Criminal enforcement, though, often struggles with procedural fairness as well as the difficult task of assigning the correct level of punishment to different forms of misconduct.
Take, for example, this last issue: the fundamental question of penalty levels. Administrative agencies commonly use financial penalties to punish regulatory violations. How should these penalties be set? Which cases require the largest penalties and which only need more modest sanctions?
Criminal law scholars will recognize this question as an inquiry about theories of punishment. Speaking broadly, criminal law considers a couple of approaches. Utilitarian theories of punishment (e.g., deterrence, rehabilitation, incapacitation) seek to punish conduct to produce beneficial social outcomes. Retributive theories emphasize desert – punishment occurs because the violator deserves punishment, not because it produces a social benefit.
So what do federal agencies do? As I argue here, administrative agencies almost uniformly talk about deterrence, but usually engage in retribution. When setting penalty levels, agencies move penalties up or down in response to facts that justify retributive punishment but do not adjust penalties in the way deterrence requires. For instance, building on Gary Becker’s justifiably famous work, Crime and Punishment: An Economic Approach, most deterrence theories emphasize the role of the probability of detection in setting penalty levels. To deter appropriately, penalties need to increase when violations are harder to detect and punish. In practice, though, administrative agencies place little weight on this issue. Instead, agencies are deeply concerned with issues like mens rea, a topic far more central to retributive theories of punishment.
Is this retributive bent in administrative enforcement surprising? Perhaps not. A large literature suggests that most people are intuitively retributive when making punishment choices. In social science experiments, study participants set penalties based on retributive concerns, but do not adjust punishment levels in ways that would be required to deter appropriately. In this way, administrative agencies look like the rest of us. We mostly care about desert even when we talk about deterrence.
The Bitcoin exchange Mt. Gox appeared to be undergoing more convulsions Tuesday [February 25], as its website became unavailable and trading there appeared to have stopped, signaling a new stage in troubles that have dented the image of the virtual currency. . . .
Investors have been unable to withdraw funds from Mt. Gox since the beginning of this month. The exchange has said that a flaw in the bitcoin software allowed transaction records to be altered, potentially making possible fraudulent withdrawals. No allegations have been made of wrongdoing by the exchange, but the potential for theft has raised concern that the exchange wouldn't be able to meet its obligations.
The apparent collapse of Mt. Gox is just the latest shock to hit Bitcoin, the price of which is now off more than 50% from its December 2013 peak:
For those better acquainted with the dead-tree/dead-president variety of money, Bitcoin is a virtual currency not backed by any government. Rather than being printed or minted by a central bank, Bitcoins are created by a computer algorithm in a process known as "mining" and are stored online or on your computer. They are bought and sold on various exchanges, including until recently Mt. Gox (whose troubles have been reported for a few weeks now).
There are many reasons, some of them even lawful. Bitcoins can be regarded as a medium of exchange, an investment, a political statement...or a way of avoiding capital controls and other pesky laws like bans on drug trafficking and human smuggling.
But the criminal potential of Bitcoin is probably overstated. The Chinese have gotten wise to its use for avoiding capital controls. Using Bitcoin for criminal or fraudulent activity would be difficult at scale (PDF). The Walter White method is still far and away the best way to ensure your criminal proceeds retain their value and anonymity.
I don't share the utopian fervor for Bitcoin expressed in tech and libertarian circles (see, e.g., this supposedly non-utopian cri de coeur), but it may have some positive potential as a decentralized and lower-cost electronic payments system. We'll see if that ever gets off the ground.
In the meantime, the Mt. Gox collapse is pretty huge news for Bitcoinland. Unlike the NYSE (the failure of which would be hard even to imagine), Mt. Gox does not benefit from any systemic significance and thus is unlikely to receive a lot of official-sector help. The situation has some early adopters running for the Bitcoin exits, like this leading Bitcoin evangelist.
Despite (because of?) my agnosticism on the currency, I'll be writing more about Bitcoin soon. (Mainly, I wanted to stake a claim to being the first to write about Bitcoin on The Conglomerate.) If your Palo Alto cocktail party can't wait, however, this explainer (PDF) from the ever-impressive Chicago Fed should tide you over.
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The prosecution is alleging some very interesting facts regarding Matthew Martoma’s past as a student at Harvard Law School. According an ABA Journal story, Prosecutors contend that Martoma was expelled from Harvard in 1999 after forging transcripts for judicial clerkship applications. According to prosecutors, Martoma submitted a forensic report to a Harvard disciplinary committee without disclosing that he founded the company that prepared that report. Martoma had a soft landing after Harvard – graduating with an MBA from Stanford and ultimately moving to SAC.
Beyond the evidentiary issues, if these allegations in the Martoma trial are confirmed, they should give law professors some pause. Student disciplinary matters are always gut-wrenching. Faculty members often hope that students can learn from mistakes. But students may be a lot more fully formed than we think by the time they enter law school. In the wake of every wave of scandals, there is always handwringing about the need for more ethics training both in law and business schools. There is an increased need for more empirical study of the effects of ethics courses and various approaches to teaching ethics. Just as we can’t extrapolate from a sample size of one, we also need to be fairly hardnosed about evaluating what does and doesn’t shape professional conduct.