The Conrad Black convictions have provided ample fodder for the press up here in Canada. After all, Lord Black is our native son who gave up his citizenship to take a seat in the British House of Lords. But apart from the human interest dimension to this story, there are some troubling legal implications for corporate governance. (Ribstein and Kirkendall offer their thoughts on the subject.)
I offer three:
I. Tort/Crime/Market � What Purpose?
The real problem with Conrad Black�s conviction and other such cases is that ordinary breaches of fiduciary duties have been converted into criminal conduct. In the realm of civil law, however, many safeguards that have developed over the years in the civil domain are hauntingly absent in the criminal arena. The �business judgment rule� for example insulates directors from civil liability when they take procedural precautions such as consult experts and document the rationale behind their decisions (I am simplifying, of course, so see Bainbridge or Ribstein for more on this). Recall that when Jamie Olis tried to use this argument (WSJ$)in his criminal case, namely that he relied on legal and accounting advice at Dynegy assuring him that the booking of loans as revenues was a valid accounting technique, he was found guilty and (initially) sentenced to 24 years! The sentence was based on a miscalculated notion of damages, again, something that would never have happened were this case in the civil litigation system. Olis� inability to raise adequate legal fees while the Feds had unlimited resources to pursue this and other cases is another imbalance in the criminal system (that some judges are trying to rectify as in the KPMG saga).
Conrad Black fared no differently. He offered the entire audit committee that approved the non-compete payments as evidence in his defense. He offered the legal advice of his lawyers as evidence of his innocence (little consolation that one of the lawyers was also convicted). Despite beating 9 out of 13 counts, he still stands to spend between 6 and 9 years in jail (let us not even start discussing the refusal of lower courts to take seriously Booker by taking into account even the acquitted counts in sentencing).
What is even odder about the Black sage is that many of these allegations were dealt with in a civil suit against Black and shareholder/BoD activism. What purpose, therefore, was served by the criminal suit?
The shareholders who were supposedly ripped off will be no richer for the conviction, nor will time served in jail help either. Given that Black was actually acquitted of most of the charges, it is not even clear what deterrence value jail time will serve. The 3 counts that he was convicted were for non-compete payments totaling $3 million. At best, a one time fine of $3 million would replenish the shareholders of their losses. There is no allegation that, as in some of the other corporate fraud cases, pensions were lost. It seems to me that had these particular non-competes been brought to the attention of the board in big 36 point font, the same board that approved all the other (totaling $50 million) non-compete payments that the jury did not find him guilty on, would have also approved them. So is it just the triumph form over substance? Even in the �business judgment rule�, if the court feels that the proper procedures were not followed, it can engage in an entire fairness test: i.e. had this been done following proper procedure would the result have been the same? Given that the board at the time seem to approve everything without reading it (by their own admission), why would these minor transactions have been any different?
As lawyers, we need to even think further out of the box. Tort and Crime are not always the way to deal with misconduct. The market acts as a powerful discipline on players (See again the works of Ribstein and Bainbridge). Economists have long recognized the role of reputations in assuring conduct. (Klein & Leffler, The Role of Market Forces in Assuring Contractual Performance, 89 J. Pol. Econ. 615(1981)) Of course, Klein and Leffler�s main condition is that any short-term gain from fraud or non-performance must be less than the possible long-term gains from honesty and proper conduct. Hence, firms will invest in branding so that they can assure customers that they are not fly-by-night operations. The problem with all the corporate fraud cases is that all (at least the ones I know) of the defendants were not the �fly-by-night� types. They were not wandering snake-oil salesmen who were swindling the masses (and frankly if you paid anything for snake-oil you were asking for it); rather, they were honest businessmen who had worked hard to build reputations and quality industries over their lifetimes. Is it not possible that when a recession hits, that businesses will fail? In the case of Conrad Black, the business never failed; in fact, it is quite alive (at least the last time I checked all the papers he used to run are still in circulation).
One of the unfortunate side-effects of this case will be that more and more entrepreneurs will flee the scene of publicly traded corporations. They may either seek the riches of private equity, or running their corporations from more forgiving regimes such as London; but a crucial question that has been unanswered is who is left behind. In an article titled "Left Behind after Sarbanes-OxleyCraig Lerner and myself authored (and presented a few months back), we argue that two types of entrepreneurs will occupy the field once dominated by those possessing animal spirits: 1. �Bean Counters� or those who revel in filling out compliance forms rather than focusing on the underlying business investments; and 2. �Swashbucklers� those who are possessed with animal spirits when it comes it to business decisions and legal compliance. They not only take risks when making business decisions, they also take risks when deciding on whether to engage in legal compliance.
The problem, of course, is that legal compliance is not even a clear concept. Jamie Olis thought he was complying with the law when he relied on legal advice, and yet a jury convicted him. Conrad Black thought an audit committee that approved the non-competes was enough. And so on. Why will honest men stick around, when what they do is still to be second-guessed by a group of US attorneys and federal judges.
More thoughts in the next post.