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June 2012 Archives

James R. Copland

In the wake of the 2008 financial crisis, New York politicians and judges have been itching to broaden the Empire State's Martin Act, which governs securities frauds. And this comes amid an explosion of criminal laws in this state.

It may sound like warranted crackdown, but don't be fooled: It's really part of a move to shift power to pols and prosecutors -- and it leaves average Joes befuddled and at risk of turning into accidental criminals.

The proliferation of criminal statutes undermines a key principle: that folks know in advance what conduct could land them in prison.

It's obvious that crimes like murder, burglary, rape will be criminally punishable. But other laws have increasingly attempted to criminalize violations of government regulations, which often span volumes, leaving the average citizen unsure of what actions might be considered criminal.

Worse, many modern criminal laws are vague or ambiguous, ensuring that we're never truly on notice of what is or isn't a crime.

Compounding this problem is the erosion of the traditional requirement of intent (what lawyers call "mens rea") -- in essence, that we can't be imprisoned for mere accident or negligence. On this front, New York fares poorly. Its modern criminal law expressly permits so-called "strict liability" offenses -- that is, you can be found guilty of a crime whether you violated the law on purpose or by accident.

In some cases, a whole book of regulations becomes crimes by default. The state Environmental Conservation Law, for instance, makes any violation of any environmental rule or order punishable by 15 days in jail for each day a violation occurs. So, if you inadvertently breach a regulation for a year, you could face up to 15 years in prison.

Moreover, many of these laws -- like the Martin Act, former Attorney General Eliot Spitzer's weapon of choice in his efforts to reshape New York's investment banking and insurance industries -- are vague, ambiguous or overly broad.

Unlike the federal securities laws and similar laws in most other states, the Martin Act doesn't require prosecutors to show that alleged wrongdoers intended to defraud, that anyone bought or sold securities relying on the alleged fraud or that anyone was even injured by the fraud.

And it makes criminal any "promise or representation as to the future which is beyond reasonable expectation or unwarranted by existing circumstances." That means that practically any forward-looking statement by any executive (including, perhaps, statements required by the federal securities laws) might be invoked as a crime.

New York law makes corporations themselves criminally liable for violations of such provisions. As such, prosecutors hold vast power to reshape corporate practices. And such reshapings may have serious consequences unanticipated by the politician-attorneys.

Consider Spitzer's deployment of the Martin Act against AIG -- at best, a distraction from the risks that would soon swamp the companies involved; at worst, a direct contributor to the risks (and consequences) themselves.

Threatening criminal action, recall, Spitzer forced AIG to oust longtime CEO Maurice "Hank" Greenberg. As Greenberg's successor, Martin Sullivan, focused on regulatory compliance and cooperation with government probes, he lost sight of AIG's financial-products group, which sold credit-default derivatives. In the nine months after Greenberg departed, AIG wrote as many credit-default swaps as it had in the previous seven years combined.

Those credit swaps ultimately brought both the company and the financial industry as a whole to its knees. It's impossible to know what would've happened had Spitzer not intervened, but UBS credit analyst David Havens maintains that the company would've never gotten into such a dire situation had Greenberg stayed in charge.

Even those who think our corporations are under-regulated should take pause at giving virtually unchecked power to government attorneys who may not fully understand the businesses they're affecting. Rather than protect the average consumer, expanding laws like the Martin Act is more likely to drive up costs, make the New York financial industry less competitive and introduce new systemic risks into the market.

In a very real sense, the expansion of our criminal law has moved us from the rule of law to the rule of prosecutors.

And if our criminal laws are too voluminous -- if we can go to jail for a mistake -- our liberty is seriously compromised.

James R. Copland

The Justice Department appears to have learned a lesson in the 10 years since it indicted Arthur Andersen LLP for alleged improprieties in the firm's Enron bookkeeping. By 2005, when the U.S. Supreme Court unanimously vacated a conviction in the case, the accounting firm had collapsed, and all but a handful of the 85,000 employees worldwide lost their jobs.

The Justice Department has since avoided large-scale corporate prosecutions that would threaten the disastrous collateral consequences brought on by its case against the former Big Five accounting firm.

But in the place of actual prosecutions, the Justice Department has aggressively pursued what are blandly called "deferred prosecution" or "non-prosecution" agreements -- DPAs and NPAs, for short -- through which prosecutors and companies negotiate terms to avoid a criminal trial. This approach may be avoiding the sort of corporate death sentence visited upon Andersen for what proved to be non-crimes, but nonetheless does something just as worrisome: It insinuates Justice Department career bureaucrats into the day-to-day management of major American businesses.

Although only 17 DPAs or NPAs were reached between businesses and federal prosecutors in the decade before the Andersen indictment, more than 200 have followed in its wake, through both the Bush and Obama administrations. Seven Fortune 100 companies are currently operating under the supervision of federal prosecutors: CVS Caremark (CVS) Corp., Google (GOOG) Inc., Johnson & Johnson, JPMorgan Chase & Co., Merck & Co., MetLife Inc. and Tyson Foods Inc.

Wal-Mart on Deck

Seven other of the 100 largest businesses have been under a DPA or NPA in just the past few years. Others, such as Wal-Mart Stores Inc., currently facing scrutiny for alleged Mexican bribes prohibited under the Foreign Corrupt Practices Act, are sure to follow.

In each of the past three years, fines and penalties levied under federal deferred-prosecution and non-prosecution agreements have exceeded $3 billion. While such fines are not insignificant, of far greater concern are the sometimes sweeping powers that prosecutors have asserted over business practices. In recent DPAs and NPAs, federal prosecutors have variously pressured companies to change long-standing sales and compensation practices; to restrict or modify contracting and merger decisions; to carry out onerous compliance and reporting programs; to appoint corporate monitors with broad discretion over management decisions; and even to oust executives or directors.

Businesses accept the agreements with such aggressive terms because they can ill afford to fight a criminal investigation. A certified public-accounting firm like the former Arthur Andersen is uniquely vulnerable to criminal indictment and conviction. But criminal inquiries place significant pressure on stock prices for all companies and can impair the ability to obtain credit. Companies can be debarred from government contracting or denied licenses upon an indictment or conviction, making businesses in certain industries, such as health care and financial services, particularly unable to fight back against a prospective prosecution.

Just since 2009, finance companies have entered into 18 federal DPAs and NPAs and health-care businesses into 11 such agreements. The finance companies alone have a collective market value exceeding $690 billion, with more than $20 trillion in assets under management.

There is essentially no evidence that DPAs and NPAs, for all their sweep, have been effective in combating corporate crime. Some corporate-ethics watchdogs have argued that current Justice Department practices, by failing to credit internal compliance programs, have undermined companies' incentives to self-police.

No Judicial Oversight

What the agreements have been effective in doing is elevating Justice Department lawyers as business regulators who can reshape industry practices without having to engage in the cost-benefit analysis that is the norm for administrative agency action. Prosecutors in this area act largely without any judicial oversight: Judges never see NPAs and routinely rubber- stamp DPAs, and these agreements typically state that determinations of whether a company is in breach are the prosecutor's alone and are beyond judicial review.

It is long past time that Congress asserted itself over the Justice Department's use of DPAs and NPAs to assume broad and unaccountable regulatory authority. Public "tough on crime" sentiment and understandable anger over unprincipled conduct by some business leaders make most politicians hesitant to suggest that the criminal law is being too harshly applied to corporations.

Still, there's little case for prosecuting corporations as entities in the first place. Unlike individuals, they can't be imprisoned. As the Arthur Andersen case demonstrated, business entities often cannot be prosecuted, either -- at least without potentially drastic effects on corporate shareholders, employees, pensioners, customers and suppliers.

Federal prosecutors have been having a profound impact on those constituencies, with broad economic consequences, in the way they have been deciding not to prosecute businesses, but rather to control them through DPAs and NPAs. In the decade since Arthur Andersen was indicted, we haven't seen a repeat of that error. But in its place we have watched as federal prosecutors assume vast powers that make them an overarching, if hidden, regulator of American business.



Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute

Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.