The Crackdown Cracks
Getting tough on corporate crime is so yesterday. The pendulum is swinging back, hitting everyone from gumshoes to judges
The hang-'em-high days of cracking down on white-collar crime may already be over. As the trial of the two former CEOs of Enron captures headlines, companies and executives are quietly winning policy changes and court rulings to water down investor protection and weaken fraud investigations, prosecution, and punishment.
Even investor champions say some retrenchment may be needed to correct overzealous regulators and prosecutors. But there is a danger that this turn of the tide could run too swift and reach too far. Periods of corporate scandal are customarily followed by reforms. "Then they fade from the public's mind, and we roll back the reforms," says Lynn Turner, a former chief accountant of the Securities and Exchange Commission who now directs research for the Glass, Lewis & Co. institutional investor advisory firm. "But I have been surprised by how quickly the pendulum has swung back this time." If the current trend continues, he warns, "the American public [will have] every right to question whether crime pays."
The pullback is evident at every level--from investigations to prosecutions to sentencing. And there's even a drive to weaken some new investor protection rules that force executives to give up conflicts of interest and do tougher audits.
Slowing the sleuths. Investigations may suffer if the Bush administration sticks with its 2007 budget, which calls for a reduction in the number of SEC investigators. Also, new legal barriers could hamper the longtime cooperation among different agencies' investigators. Several judges have dismissed charges against defendants because of concerns that overlapping investigations might result in a kind of double jeopardy. The judge in HealthSouth Corp. CEO Richard Scrushy's trial, for example, tossed out some of his charges last spring, saying the coordination between the SEC and the Department of Justice created an unfair "perjury trap" for Scrushy. Civil regulators can fine suspects who don't cooperate. But those who do talk risk providing incriminating evidence that will send them to jail on criminal charges. (Scrushy was eventually fully acquitted.) A federal judge in an Oregon accounting fraud case made a similar ruling in January.
And the SEC last month overturned a lifetime investment industry ban of former Credit Suisse First Boston banker Frank Quattrone, ruling that he should not be penalized for invoking his right to silence. These decisions can't help but make investigators more careful and defense attorneys more aggressive, says Brent Gurney, a former federal prosecutor now in private practice. "Defense attorneys are going to take advantage of these cases, absolutely," he says. Investigators are also losing a weapon they've been using to persuade people and companies to turn state's evidence. Until recently, prosecutors could get corporations and executives to turn over sensitive records--including attorneys' memos that are traditionally kept private--by threatening tough sanctions on those who didn't cooperate. But earlier this month, the U.S. Sentencing Commission voted to no longer penalize those who insisted on their attorney-client privilege.
Probers will still be able to subpoena materials like E-mails and general business records. But business and legal groups are taking the retreat on attorneys' notes as a sign that "there is a shift in momentum" that may allow them to neutralize other threats investigators often use, says Susan Hackett, senior vice president of the Association of Corporate Counsel. Her group next hopes to persuade Congress and the administration to eliminate punishment of companies that pay the legal fees of accused executives. "We are going to tackle one thing at a time," she says.
Please pass the pleas. Prosecutors may be retreating a little, too. A criminal indictment of employers may cause financial devastation to innocent employees. So prosecutors have started offering sweeter plea agreements to corporations. Since 2004, federal prosecutors have struck at least nine deals with companies accused of accounting fraud, to defer prosecution or not prosecute at all. In the previous five years, the Justice Department announced just four, according to the Corporate Crime Reporter. The deals, which require companies to turn over material incriminating executives, have helped prosecutors win guilty pleas and convictions of executives at Adelphia Communications, MCI, and several other companies.
But Russell Mokhiber, editor of the newsletter, worries that prosecutors may be getting too soft. In February, for example, the Justice Department agreed to defer prosecution of insurance giant American International Group on criminal charges of accounting fakery from 2000 through early 2005 because it "agreed to accept responsibility for its actions" and paid $825 million in federal fines and restitution. AIG also settled New York State charges that it rigged insurance bids, for $818 million. Prosecutors allowed AIG to avoid trial even though a division of the company is operating under a 2004 agreement for other accounting misdeeds. "How many free bites of the apple are we going to give corporations?" Mokhiber wonders.
Shorter sentences. Some judges are also easing up on the punishment of white-collar criminals. In 2005, the Supreme Court declared unconstitutional the harsh mandatory sentencing rules that resulted in prison terms of 20 years and more for many corporate wrongdoers. As a result, some convicted defendants, such as Dynegy executive Jamie Olis, who was sentenced to 24 years, have won appeals that could reduce their jail time.
And others have won lighter sentences from judges now freer to show leniency. Former Adelphia Executive Vice President Michael Rigas, who had pleaded guilty to lying to the SEC, was last month sentenced to 10 months of home confinement. His father and brother, who were convicted of much more serious charges, were ordered to spend 15 and 20 years, respectively, behind bars for their parts in the cable company's $3 billion accounting fraud. But federal Judge Jed Rakoff said Michael Rigas was "a good person who found himself to be at the wrong place at the wrong time."
Relaxing the rules. Many businesses are hoping this retreat will even reach all the way back to the tough new rules on executives' conflicts of interest and disclosure to investors. A federal appeals court early this month agreed with the U.S. Chamber of Commerce that the SEC had improperly rushed a rule requiring that a mutual fund chairman be independent of the fund's management. It gave the SEC 90 days to consider more public comments and reconsider its orders.
And business lobbyists are winning bipartisan congressional support for a proposal that would exempt small public companies--which represent the vast majority of all public companies but less than 6 percent of the total market's monetary value--from some of the tough auditing requirements of the 2002 Sarbanes-Oxley Act. "They took a sledgehammer to kill a fly," complains Ted Schlein, a managing partner at the Kleiner Perkins Caufield & Byers venture-capital firm, of Sarbanes-Oxley. He is a member of an SEC small-business advisory panel that came up with the exemption proposal.
Schlein, who sits on the board of several small companies, says accountants charge $1 million to $2 million to perform a full audit. That can often wipe out a small company's entire annual profit. "And what did the investors get?" he wonders, saying that very few of the audits reveal significant problems. At the very least, lobbyists expect the SEC to push back this summer's deadline for small-business audits to allow Congress to hold hearings and hash out a proposal.
Some of the toughest investor advocates agree that a few reforms--such as reducing some corporate fines, since they typically just come out of investors' pockets--are needed. But they worry about the overall trend. "Four years after President Bush said it was the most important legislation since the Depression ... I have been stunned by the willingness to say Sarbanes-Oxley was a big overreaction," says Nell Minow, founder of the Corporate Library, which helps investors analyze companies' governance. It all seems sadly familiar to corporate-crime experts like Dan Dooley. He is a Pricewaterhouse-Coopers forensic accountant for more than 30 years who conducted internal postmortems of several corrupt savings and loans, disgraced junk bond powerhouse Drexel Burnham Lambert, and, recently, Xerox. The current crackdown has made investing in American companies safer by "removing temptation from honest people who might go astray," Dooley says. But he doubts much can be done to deter the 3 to 5 percent of business people he believes are incurable fraudsters. So just as the cleanup of the savings-and-loan frauds left loopholes that eventually led to Enron, the recent retrenchment and investors' seeming relaxation of vigilance may sow the seeds of the next investor debacle, he says.
Where will scandal strike next? Watch out for foreign companies, Dooley warns, especially those in developing countries. Americans hunting for juicier profits have been pouring dollars into companies in countries whose investor protections are even laxer than those here. Foreign investments took 77 percent of all new mutual fund stock dollars last year. Many investors, it seems, may already have forgotten the painful lessons of Drexel and Enron: Bigger rewards generally reflect bigger risks.
This story appears in the April 24, 2006 print edition of U.S. News & World Report.