There is scarcely one month without a corporate executive being charged with some crime or jailed for something. The Wall Street Journal runs a special on-line section about “Executives on Trial.” Just last week, four former WorldCom employees were sentenced to jail terms for such offenses as securities fraud, conspiracy, and false filings. Is what the media call “the largest accounting fraud in U.S. history” hidden behind these offenses? Thinking out of the box is required.
Fraud is a serious matter; or, perhaps, should we say, serious fraud is a serious matter. People generally exaggerate their qualities and play down their shortcomings in their curriculum vitae, sales reps pitch the good features and hide the faults of their products, preachers sell recipes for eternal life, politicians sell panaceas to voters, and corporate executives cajole analysts and investors. But only corporate executives are subjected to arcane securities and governance laws where fraud pops up everywhere.
Serious or systemic fraud is a serious matter for many economic and moral reasons, including the fact that a minimum level of honesty and trust is necessary for a free, thus efficient, society. But isn’t it possible that the continuous invention of new regulatory frauds undermines the gravity of real fraud, and damages our social capital of honesty instead of protecting it?
The assault on business executives did not start with Enron. In August 1989, Robert Freeman of Goldman Sachs was pressured into pleading guilty to one count of “wire fraud” after being prosecuted for insider trading. “He had the surreal experience,” wrote the Wall Street Journal, “of a defendant pleading guilty to the questionable crime of having been told, ‘Your bunny has a good nose’.”1 (The “bunny” was a reference to a trader nicknamed “Bunny”.) He was condemned to three months in jail. Another example from the same period: Michael Milken was charged with 98 counts, finally forced to plead guilty to six mostly technical offenses (not including insider trading), and spent two years in jail. A few of the fallen financiers (like Ivan Boesky) were crooks in breach of private contracts or trust, but many – probably most – had only ran afoul of securities regulations and the state’s widening definition of fraud.2
What we have seen since the beginning of the 21st century looks like a repeat of the witch-hunt of the 1980s, but with the reinforcement of the governance craze and ten more years of anti-capitalist business ethics. Are there real crooks among the several business executives awaiting their trials or condemned to jail? The answer is far from obvious.
Kenneth Lay, former Enron chairman and CEO, is awaiting his trial for – guess what? – securities fraud and wire fraud, besides facing SEC’s charges of fraud and insider trading. After a second trial, the government has succeeded getting Tyco’s former CEO, Dennis Kozlowski, found guilty of looting his company, but note that, as usual in these cases, he was charged by the government, not by his board, and that his partying in Italy and lavish lifestyle had excited much envy.
Bernard Ebbers, former chairman and CEO of WorldCom was found guilty of securities fraud, conspiracy and causing the company to make false filings with securities regulators, and is likely to spend the rest of his life in jail; serious accounting manipulations appear to have been made, but he denies having been aware of them. After a first mistrial, the government finally fell Frank Quattrone, formerly of Credit Suisse First Boston, for obstruction of justice, and sent him to jail. Others were found, or pleaded, guilty. A few were acquitted.
Some executives and managers have implicated their higher ups, and testified against them. WorldCom’s CFO testified against Bernard Ebbers. Enron’s CFO pleaded guilty and admitted conspiracy. Three WorldCom accountants alerted the SEC, the FBI and the Department of Justice, hoping to not get indicted; they were anyway, but got relatively short jail sentences. What are these confessions worth? Scaring people into cooperating and denouncing others was a common tactic in the 1980s’ persecutions, and only a few now forgotten heroes, like Robert Freeman, refused to give in. Freeman also refused to make the usual public confession, reminiscent of the Soviet dissidents’ autocritique.
In fact, what may be called the repentant-witch syndrome is much older. During the witch-hunts that marred Europe (and even America) between the 15th and 17th century, it was common for the terrified witch to try to save her skin by confessing and accusing her neighbors, sometimes her relatives. Agents of the contemporary anti-corporate Inquisition have also become masters at scaring witches into denouncing other witches.
Modern inquisitors fail to grasp that a competitive business is not a government bureau. Because taxpayers are forced investors in the state, and because the state is powerful and dangerous, tight rules and procedures are imposed on bureaus and bureaucrats. The necessity of constraining the state implies that the rules are often more important than the results. A competitive business could not survive under this setup.
The board of directors is given a wide margin of discretion by the shareholders, who are free to bail out if the results are not there. The board grants much discretion to executives (like Kozlowski), who will be fired if they don’t produce results – let alone if they “loot” the company. Decisions have to be made quickly. Rules are more guidelines than absolute constraints. The efficiency of business enterprises depend on this flexibility. Any inefficient business is quickly punished by the market.
It may very well be that some of the executives recently charged or condemned were guilty of real frauds, like the accounting manipulations confessed by some WorldCom accountants – but remember the repentant-witch syndrome. Many of these cases are very complex. There is an urgent need to search for the truth, instead of simply asking whether somebody has committed the latest state-defined fraud. The imprisonment of Martha Stewart for having lied to a government bureaucrat-cop, and the image of her walking out of jail with an electronic bracelet on her ankle, are more than just stains on so-called free societies.
The anti-corporate crusade would not be as worrisome if the state was small, and its mistakes were seldom very harmful; if people still admired the emblematic figure of the defense attorney, instead of venerating the Rudolph Giulanis of this statist world (Giuliani was the district attorney who put Milken behind bars); if state fraud had not become a much more clear and present danger than corporate fraud.
“If, for example, existing government intervention is minor, we shall attach a smaller weight to the negative effect of additional government intervention,” wrote Milton Friedman. “This is an important reason why many earlier liberals, like Henry Simons, writing at a time when government was small by today’s standards, were willing to have government undertake activities that today’s liberals would not accept now that government has become so overgrown.”3 It is now difficult to trust the state’s definitions of fraud and its procedures for determining guilt.
Not surprisingly, the preying of the state on deep-pocket defendants has signaled, and facilitated, an open season for rent seekers. Criminal prosecutions and civil suits by the state are followed by class actions. Former bankers of Enron recently settled a class action suit for close to $7 billion, and settlements by other large banks are still to come. Interestingly, the plaintiff’s attorney and negotiator, William Lerach, who is famous for suing companies in the name of “defrauded” investors, is under criminal investigation for allegedly bribing plaintiffs and witnesses.4 Whatever comes out of this case, it is not surprising to see lawyers’ greed fueled by galloping legislation. Like real fraud and contrary to market greed, this sort of public greed causes great harm.
I may be slightly off the mark on this, but I suspect that, when our descendents look back at our epoch’s Inquisition, it will be with the same sense that today’s self-righteous intellectuals look at the pre-modern witch-hunts. They will realize what great injustices have been done to suspected witches. Whether they will be able to speak about it is another matter.
- 1“Changing of the Prosecutors,” Wall Street Journal, September 11, 1989.
- 2See my Apologie des sorcières modernes (Paris: Belles Lettres, 1991).
- 3Milton Friedman, Capitalism and Freedom (Chicago: University of Chicago Press, 1962), p. 32.
- 4“Prosecutors Set Up Probe of Milberg Weiss Law Firm,” Wall Street Journal, August 8, 2005. Bribing somebody to falsely accuse a third party is more than just bribing: it is conspiracy to commit a real crime.
