Corporations in the Dock

In the last few months various federal and state agencies have gathered up enormous fines from the big banks. The Economist estimates the total at $35 billion, with Bank of America (rumored in the $15 billion range) and others still to be heard from. Among the recent contributors to the public fisc were JPMorgan Chase ($15 billion for dicey mortgage sales and foreclosures), BNP Paribas ($8.9 billion for money laundering), and Citigroup ($7 billion for misleading investors).

So the question for today is: Can the banks have done any of these things? Or more generally, in what sense can a corporation be said to do anything? After all, a corporation is simply an organizational form for doing business. It doesn’t have beliefs or desires, and it cannot act except through individuals. So when we say that a corporation “did” something—laundered money or lied to investors, for example—what we really mean is that individuals acting for the corporation did the laundering or lying. Saying that the corporation did something is merely a façon de parler: useful in many contexts, misleading in others.

There is a legal doctrine, respondeat superior, that makes a business owner (including a corporation) responsible for the tortuous acts of an employee. For example, if an employee driving a truck on the owner’s business negligently injures a pedestrian, the owner can be liable for the employee’s negligence. It’s not that the employee is excused; both he and the owner are liable. But it’s usually the owner that gets sued because that’s where the money is.

Early in the twentieth century the concept of respondeat superior was ported over from tort law to criminal law: A corporation could be criminally liable for the criminal acts of its employees. A corporation can’t go to jail of course, but it can pay a fine, lose a governmental license, or have certain business practices enjoined. Much later in the twentieth century, in the wake of Enron and other gaudy scandals, the penalties for corporate crimes were greatly increased. (An article by Joan McPhee, a partner at the Boston law firm of Ropes & Gray, explains the evolution.)

Of course, when we say the corporation pays a fine, loses a license, or has its conduct curtailed, we should understand that we’re really talking about consequences for individuals. For the most part, it’s the corporation’s stockholders, not “the corporation,” who bear the costs. (Similarly, if someone forges your name on a check, it’s you and not your checking account that will be the loser.) But why should the stockholders suffer for the illegal act of a corporate employee? There are a number of explanations, not all equally plausible.

First, if the employee’s conduct benefited the corporation, as it might where a corporate customer is defrauded, it seems only fair that the corporation/stockholders return the ill-gotten gains. But this explains only a small part of what’s been going on recently, where no one bothers to reckon how much the corporation may have profited and little thought is given to paying over the fines to the victims of the employees’ acts.

A second explanation is that the guilty employees usually don’t have the resources to fully compensate the victims. But this argument would never pass muster outside the corporate context: If your neighbor defrauds someone but can’t fully compensate his victim, should you have to pay the difference? In any case, little of the fines go to the ostensible victims of the fraud or other illicit conduct.

A better reason for making stockholders pay is that the possibility of punishment will encourage them to prevent illicit conduct. In a modern US corporation, the stockholders elect the company’s directors, who in turn elect and monitor the company’s officers. Unlike the directors, who only serve part-time, officers are full-time employees who run the day-to-day affairs of the corporation, including hiring and firing lower-level employees. If the stockholders can be punished with heavy fines, they will elect responsible directors, who will in turn appoint responsible officers, who will in their turn institute measures to prevent criminal conduct, including more closely monitoring the corporation’s employees.

Corporate officers don’t like to explain to more senior officers or to directors why their operations incurred governmental wrath, not to mention heavy fines. But the problematic conduct usually would have occurred up and down the line: Employees and officers engaged in illegal conduct, and more senior officers, directors, and stockholders were not sufficiently attentive. However, as one moves from employees to officers to directors to stockholders, the ability to control the conduct of underlings, and the degree of culpability, rapidly erode. So why does the least culpable group, the stockholders, take nearly all the hit?

One reason is that the process is controlled by prosecutors and corporate officers, and it is in their mutual interest that things work this way. One manifestation of this mutuality is that while corporate crimes must be committed by the corporation’s employees, the guilty individuals usually suffer no punishment more grievous than losing their jobs. (Their legal costs are almost invariably paid by the corporation—that is, by the stockholders.)

For a prosecutor, pursuing corporate employees for criminal activities raises all sorts of problems. For one thing, it requires amassing detailed evidence as to the employees’ activities. Moreover, juries are much more likely to punish an abstract entity like a corporation than a flesh-and-blood employee, so indicting individuals can prove embarrassing. (In the Tap Pharmaceuticals case, for example, the company settled for $875 million and an onerous corporate integrity agreement, after which a jury acquitted the 13 corporate employees whose supposed crimes were the basis for the charges against the company.) And massive fines, of a size that no employee could pay, are profitable for the government and produce headlines that can make a prosecutor’s career (the Rudi Giuliani effect).

On the corporate side, no one wants to go to jail, least of all well-paid corporate directors and officers. Far better to take the question of individual guilt off the table and lumber the stockholders with the fine. (Directors and officers are usually stockholders too, but they bear only a miniscule percentage of the economic damage.) Most important, a criminal conviction—even an indictment—can be a death knell for a company. (The accounting firm Arthur Andersen collapsed after being indicted. Its subsequent conviction was posthumously overturned by a unanimous Supreme Court.) Better to settle for a sum that, while impressively large, does not threaten the company’s existence.

The result is that corporate criminal prosecutions have turned the Justice Department into a kind of protection racket. Since no individuals are charged and the corporation cannot risk an indictment, let alone a conviction, prosecutors do not have to put any facts before an independent judge and jury. Instead, the prosecutors and the corporation simply agree on a dollar settlement that will be large enough to burnish the prosecutor’s resume while permitting the corporation to survive without having any executives go to jail.

Viewed this way, corporate criminal prosecutions resemble certain types of civil actions. In most states there is “strict liability” for death or injury caused by defective products. That is, the victim needn’t prove negligence in the design of the product, only that it was defective. Even though no one at the manufacturer was derelict in their duty, the corporation is still required to compensate the victim. The usual explanation for such a rule is that where someone is victimized by a faulty product, it’s the corporation that was best placed to avoid the injury by preventing the product defect.

Whatever you may think of strict product liability, the similarities with corporate criminal prosecutions are dwarfed by the differences. Most obviously, a plaintiff in a product liability case will have to prove to a court that the product was truly defective, that the defect caused the injury, and the amount that will adequately compensate for the injury. In a corporate criminal prosecution, in contrast, prosecutors will not have to prove that a crime was committed or the amount of the damages because the corporation cannot risk going to court. Moreover, no part of the settlement need go to the ostensible victims. (As Floyd Norris noted in The New York Times, in Citigroup’s recent $7 billion settlement of charges that it misled investors in mortgage-backed securities “there seems to have been no effort to quantify just how much Citigroup’s improper behavior cost investors,” and “there is nothing in the settlement to benefit most of those affected.”)

It’s understandable that prosecutors will want to raise money for the government and to make their careers, and that corporations will want to avoid oblivion. But what makes this situation possible is public anger over particular corporate scandals such as Enron and, more generally, over the recent recession. But anger is a poor guide to action. Anger over 9/11 leads us to blame Muslims generally, with results  both silly—stopping a mosque near the World Trade Center site—and tragic—invading Iraq. In each case there is what we might call a metaphysical confusion, which leads us to punish innocent individuals who are connected in our minds with an abstract entity, Islam or the corporation. (Strangely, many people who attack the Supreme Court decisions in Citizens United and Hobby Lobby by denying that a corporation can have speech or religious rights seem willing to accept that a corporation can have the mental state—mens rea—requisite for the commission of a crime.) The result in the corporate context is a corporate version of lynch law where, without any determination by an independent fact-finder, innocent stockholders are hung, drawn, and quartered.

—Stan