Corporate Liability in the Era of Regulatory Rollback

For well over a century, the Western world, led in large part by the United States’ unyielding economic development in the post-war 20th century, has ascribed to the ideals of a free market economy, which fosters entrepreneurial behavior and calculated risk-taking. Both features are essential, it is argued, to economic prosperity. However, the free market cannot operate in a vacuum, and legislators have rightly recognized that even a liberal system which places an emphasis on private ventures and self-regulation needs to be tempered with an overarching framework of rules.

Up until very recently, it could be said that this framework of rules – which included, for instance, the pivotal Securities and Exchange Act of 1934, which was developed as a response to one of the worst economic crises in US history – was doing its job satisfactorily. A case in point is the 1980s savings-and-loan crisis, in the wake of which nearly 900 bankers were sent to jail for complex financial fraud. Moreover, after the notorious Enron implosion in the early 2000s, Arthur Andersen – a former “Big 5” accounting firm – lost its accounting license, and several top executives were prosecuted and convicted for. These are but 2 examples of a whole slew of cases where the law sent a clear message to the financial sector – corporate crime will not be tolerated, and jail time is a very real prospect for those who engage in it, regardless of their status or influence in the industry. For better or for worse, the punishment served as a deterrent, or, at the very least, a constant reminder of what was in store for those who placed profits over propriety.

A Recent Shift

However, this seemingly irreplaceable doctrine of our judicial reasoning – that punishment follows the crime – has, in many ways, recently been displaced in relation to white-collar crime. Jesse Eisinger, an experienced Wall Street Journal commentator and renowned author of the aptly named Chickenshit Club, explains that there are now, in effect, two sets of laws: one which applies to the small-town dealer on the street corner, and another which is in force for the Manhattan executive in a glass-paned office. The former gets three strikes, after which a prison sentence, coupled with very high legal fees, is almost guaranteed. The latter, unlike in the cases of Enron and Arthur Andersen, will nowadays probably be asked for little more than a disgorgement of profits, the sum of which will equal a one-digit-percentage of the overall gain from the fraud in question. In the words of Jed Rakoff, an outspoken critic of the current legal trajectory, even multimillion-dollar fines (usually imposed on multibillion-dollar companies, to note) are seen as little more than a “cost of doing business”.

How did this dramatic change come about? Eisinger argues, it was precisely one of the biggest successes of corporate prosecution – namely, the dissolution of Enron and the delicensing of Arthur Andersen – that led to the system’s demise. As many have pointed out, although there was an undeniable sense of “justice being served” after the accounting giant’s fraud was discovered and adjudicated, the collateral damage which was caused was truly enormous. With over 80,000 employees worldwide left jobless in the wake of the crisis, most of whom were not involved in the shady practices of the top management and board, people started to question and reevaluate the necessity of having such a strict, policy-driven legal system. To some, this effort appeared to punish one bad deed by causing another. One of the most significant byproducts of this reevaluation was the replacement of the Holder Memo with the Thompson Memo, which redefined the purpose and methodology of corporate prosecutions within the Department of Justice. A much greater emphasis was placed on cooperation with the company under investigation and on preserving its corporate form and the services it provides to society, while exacting punishment primarily through legal fines. Moreover, with budgets under constant strain, much of the investigatory work was outsourced to private companies which often had long-standing relationships with the corporation they were investigating. This created a “revolving door” environment, where company A would be investigating company B one day, but then making a deal with it on another, which cast strong doubt on the impartiality of results produced in this way. The justice system, it seemed, had become so scared of causing another “Andersen” that it tied its own hands regarding white-collar prosecution.

A Natural Consequence: 2008

It should come as no surprise, then, that by the time the 2008 global financial crisis occurred not more than a few years after Enron collapsed, the prevailing legal culture of prosecution had shifted to actively discouraging any “radical” moves that had the potential to seriously disrupt the economic equilibrium. Notwithstanding the fact that the crisis caused a surge in unemployment rates – more than doubling them in the US with even worse consequences abroad – and has since been described as the worst economic disaster since the Great Depression, none of the top bankers, managers, or CEOs who significantly contributed to it went to jail as a result. The Financial Crisis Inquiry Committee referred a large number of potential candidates to the Department of Justice, from Morgan Stanley, to Merrill Lynch, to Lehman Brothers, to Countrywide. Dozens, if not hundreds, of people were implicated, and yet, there were no indictments, no trials, and no prison sentences.

This is not to say that there were no consequences. The banks paid $243 billion in fines, reconciliations, and damages, with Bank of America, for instance, bearing no less than $76 billion of that on its own. Additionally, mortgage-valuation regulations have been revised to prevent such a crisis in the future. Understandably, however, many were not content with this outcome. What do fees matter when the CEOs got bonuses, the banks weren’t put out of business, and no one had to forego the comfort of their office chair for the cold walls of prison? Jesse Eisinger remains at the forefront of this critique, and has disparaged the legal system for not taking a harsher stance against financial fraud. Consider the recent example of HSBC, which was accused of knowingly laundering money for Mexico’s Sinaloa cartel and Al Qaeda-linked Saudi extremist groups. Despite this, all that the American justice system offered was a summons of HSBC’s top executives to Capitol Hill for a “ritual display of chastisement”, a $2 billion fee that, in truth, equaled around 4 weeks of the bank’s profit, and a pledge by the bank to “clean up” its institutional culture. Eisinger’s 2-tier justice system, it seems, is alive and well in America.

Bozidar Bogosavljev received his LL.B. from Queen Mary University of London with first class honors and is currently a candidate for the Corporation Law LL.M. at New York University. His interests primarily revolve around corporate, securities, and finance law, and he aims to pursue a career in this area upon graduation. Bozidar is also a Research Fellow at the NYU Pollack Center for Law & Business and a representative of the NYU Law & Business Association.