Prosecutors in the Boardroom: Using Criminal Law to Regulate Corporate Conduct

1. The Causes of Corporate Crime: An Economic Perspective

| 11 1 The Causes of Corporate Crime An Economic Perspective Cindy R. Alexander and Mark A. Cohen This chapter examines the causes of corporate misconduct from an economic perspective, focusing on crime. Our purpose is to provide an understanding of why corporate misconduct occurs and to identify some considerations that are important to enforcement authorities and corporate monitors in determining how best to deter it. These considerations have grown in importance over the past decade, especially with the emergence of governance reform and the related use of DPAs as means for promoting monitoring and related deterrence of crime in business organizations.1 The threat of sanction is central to the deterrence of corporate crime in this setting. This includes the chance of getting caught and the penalty that the offender expects to pay, if caught. Two features of crimes by corporations are key. First, crimes tend to be committed by multiple individuals, not just by one individual acting alone. Second, individuals are linked within corporations through what some economists have termed a “nexus of contracts.”2 This means that individual choices in the corporation are linked in a predictable manner, depending on the firm’s structure and governance. The actions of individuals who would never think of committing a crime can influence the actions of those who are more prone to misconduct. The possibility of deterring crime by penalizing—or holding accountable—an individual who does not directly engage in crime is thus apparent; blaming the top management for inadequate internal controls or a corporate culture that fosters crime can be an effective response to corporate crime in some instances, even when the top management had no direct role in the offense. Similarly, holding shareholders accountable (via the corporate entity) can be an effective means of deterrence in settings where the corporation is generally responsive to the interests of its shareholders, the enforcement authority faces difficulty in identifying the guilty employee (or the guilty employee is judgment proof), and the shareholders are not themselves an injured party in the misconduct. 12 | Cindy R. Alexander and Mark A. Cohen Reforms to governance at the top of the corporation have thus emerged as a potentially effective substitute for higher monetary sanctions in deterring corporate crime. This can be seen in the past decade’s reforms under the Sarbanes-Oxley Act of 2002 and in the increased use of prosecution agreements , notably DPAs and NPAs (see Figure 1.1).3 The framework of this Chapter applies across the wide array of offenses for which corporations may be held accountable, including violations of health, safety, or environmental regulations; antitrust conspiracies; bribery and corruption on government contracts; and securities fraud. In the United States, those legally responsible for corporate crime can be as varied as the hourly employee who illegally dumps a barrel of hazardous waste, the manager who conspires with competitors to rig bids on a local road-building project, or the senior executive who fails to put effective controls in place to ensure that foreign government officials are not bribed to obtain a contract or that the firm’s financial reporting practices meet the needs of investors. The pattern of increased reliance on prosecution agreements is apparent even when compared with the use of traditional criminal sanctions around the peak period of their use, during 2004–2007. While there has been only a slight decrease in the number of traditional criminal prosecutions resulting in fines of more than $1 million, the number of companies without criminal prosecution but having fines of more than $1 million and a prosecution agreement increased dramatically from as few as seven in 2004 to as many as thirty in 2007. Combined, the number of companies receiving $1 million or more in sanctions doubled, with the number in 2007 being 105 Figure 1.1 Publicly Announced DPAs and NPAs, by Year (estimated) 20 15 10 5 0 1993 1994 1995 1996 2001 2002 2003 2004 2005 2006 2007 2008 DPA NPA The Causes of Corporate Crime | 13 percent higher than in 2004. Our evidence is that more than three-quarters of the prosecution agreements were accompanied by monetary sanctions of more than $1 million in this period. The early experience is that prosecution agreements may be a less costly means of delivering monetary sanctions than traditional channels of criminal enforcement. Since the two can deliver sanctions for similar conduct, they can be thought of as substitute means...