Prosecuting Corporate Crime when Firms Are Too Big to Jail: Investigation, Deterrence, and Judicial Review.

Author:Werle, Nick

NOTE CONTENTS INTRODUCTION 1368 I. THE TOO-BIG-TO-JAIL PROBLEM 1374 II. CORPORATE CRIMINAL LIABILITY 1380 A. Legal Constraints 1380 B. Microeconomics 1381 III. THE ECONOMIC MODEL: TOO-BIG-TO-JAIL PROSECUTION 1386 A. Outline of the Law Enforcement Game 1388 B. Observable-Effort Baseline 1391 C. Moral Hazard 1394 D. Moral Hazard with Internal Controls 1394 IV. THE TOO-BIG-TO-JAIL FIRM'S DISINCENTIVE TO COOPERATE 1398 V. STRATEGIC IMPLICATIONS FOR CORPORATE CRIMINAL PROSECUTION 1403 VI. REFORMING CORPORATE SETTLEMENT 1407 A. Identifying the Source of the Problem 1408 1. The Law and Practice of Deferred Prosecution 1408 Agreements 2. Why Do Corporate Settlements Generate Relatively 1411 Few Individual Prosecutions? B. A Proposal for Reform 1416 1. Strengthening Judicial Review of Deferred 1417 Prosecution Agreements 2. Prohibiting Corporate Nonprosecution Agreements 1422 3. Improving Structural-Reform Mandates and Increasing Political Accountability for 1424 Law Enforcement Strategy CONCLUSION 1427 APPENDIX A: MATHEMATICAL APPENDIX 1429 APPENDIX B: DEFERRED PROSECUTION AGREEMENT PROCEDURES ACT 1434 INTRODUCTION

Since 2000, the U.S. Department of Justice (DOJ) has prosecuted numerous companies for a range of crimes, including fraud, bribery, environmental crime, occupational safety violations, antitrust, and money laundering. (1) But relatively few of these cases have resulted in charges against culpable individuals. From 2001 to 2014, individuals faced prosecution in only 34% of the 306 cases in which federal prosecutors reached negotiated criminal settlements with corporate wrongdoers, with only 414 total individuals prosecuted. (2) Although the pace of corporate criminal settlements has increased since 2001, the proportion featuring individual prosecutions and the total number of individuals given custodial sentences have barely changed. (3)

Even when individuals are prosecuted, they are generally sentenced more leniently than defendants who faced similar charges outside of the corporate-crime context. Namely, defendants in corporate-crime cases who plead guilty or are convicted receive jail sentences less frequently and serve less jail time than do defendants facing similar charges for noncorporate crime. (4) The divergence between firm-level prosecutions and the dearth of individual prosecutions has fomented a popular narrative that the government permits managers to buy their way out of trouble, using shareholder assets to avoid individual criminal penalties by agreeing to criminal settlements. (5)

Despite this, the law-and-economics literature has suggested that government can, in some circumstances, deter corporate crime using entity liability alone. (6) Both theoretical and empirical studies treat corporate-crime control as an agency cost, since intrafirm information asymmetries stymie the monitoring of employees, who may engage in criminal conduct for private gain. Models of corporate crime treat this intrafirm agency problem as nested inside another agency relationship, with government seeking to deter corporate crime through a mix of incentives for corporate cooperation and punishment for wrongdoing. These standard models treat prosecutors' decisions to apportion criminal liability between companies and culpable individuals as merely discretionary choices between strategic substitutes. (7) The "optimal" punishment in the aggregate is one that forces companies and their managers to internalize the social costs of their criminal conduct. According to this theory, the government can optimize deterrence via a range of different strategies, such as (1) only prosecuting and fining corporations, (2) only prosecuting culpable individuals, or (3) adopting a mixed strategy in which prosecutors bring charges against corporations and employees. Taking DOJ policies on their face, the government has tried to prosecute both companies and individuals. DOJ employs a regime of aggressive fines, with discounts for corporate cooperation and self-reporting that purport to induce companies to invest in elaborate compliance and internal-investigation systems and to proactively disclose employee wrongdoing. According to economic theory, these threats all operate ex ante, with the risk of punishment and rewards of lawful cooperation shaping corporate practices and managerial behavior.

But does this strategy work? Does imposing large fines on corporations actually deter corporate crime? (8) Recent history suggests not. In his comprehensive 2014 study of corporate criminal prosecution, Brandon Garrett found that corporate recidivism rates remain disturbingly high. (9) He identifies as particularly troubling cases in which prosecutors find a company violating the law while subject to an active deferred prosecution agreement (DPA)--a contract that ostensibly prohibits future criminal conduct and requires ongoing cooperation with prosecutors. (10) These repeat offenses should result in sentencing enhancements when the new criminal charges are resolved, and they should prompt prosecutors to trigger breach proceedings under any existing DPAs. But this rarely happens; Garrett concludes that "[i]t is not at all clear that prosecutors take corporate recidivism seriously." (11) Indeed, the list of recidivists with multiple corporate convictions in quick succession includes industry giants such as BP, ExxonMobil, Pfizer, GlaxoSmithKline, AIG, Barclays, HSBC, JPMorgan, UBS, and Wachovia. (12)

The Too-Big-to-Jail (TBTJ) problem therefore signifies the "concern that some companies may be so valuable to the economy that prosecutors will not hold them accountable for crimes." (13) When defendant companies are so large, so systemically important, and so politically powerful that prosecutors cannot credibly threaten them with a "socially optimal" penalty, does deterrence still work? This Note contends that when firms become TBTJ, deterrence breaks down. When prosecutors set law enforcement strategy to deter crime by powerful firms, the standard economic incentives fail to adequately disincentivize criminal activity. Given this, prosecutors should modify their strategic objectives and investigative tactics to effectively manage the problem of corporate crime.

The Note presents a microeconomic model of corporate criminal prosecution in the context of TBTJ business organizations. It shows that when a defendant firm is TBTJ, prosecutors may be unable to induce it to cooperate with the government in good faith. The model also shows that there are conditions under which managers of TBTJ firms evaluating whether to engage in unlawful conduct may find criminality profitable for themselves and their firms. In this context, prosecutors should account for these unique political-economy constraints by encouraging third-party monitoring, rather than relying exclusively on internal corporate investigation. They should also further prioritize resolutions that mandate structural reform on companies and impose nonmonetary sanctions on culpable individuals, rather than on corporations alone.

The following hypothetical illustrates the basic TBTJ dynamic. Consider the decision-making process of managers in a global but thinly capitalized bank evaluating a highly profitable but illegal opportunity. These managers have the option to offer to an important client population a product such as an opaque cross-border transaction that facilitates income-tax evasion and laundering of drug-trafficking proceeds. Imagine further that during a recent liquidity crunch, this bank had received a government bailout because policymakers feared that--due to its size and interconnectedness--the bank's default would trigger financial contagion and destabilize the national banking system. By providing a bailout, the government impliedly announced that the bank was Too Big to Fail (TBTF). Suppose the bank managers assume that if they engage in illegal conduct, they will earn $500 million in profits, and there is only a 10% chance the government detects the transaction and prosecutes the bank. Crudely, one can say that, if convicted, the optimal fine would be $5 billion because that would make the transaction unprofitable from a cost-benefit perspective. (14) But the managers may also know that government regulators believe that a fine of $2 billion or more will catastrophically weaken the bank's balance sheet and imperil the broader financial system. In this situation, the managers may credibly conclude that the government will not intentionally damage the bank and trigger a financial crisis requiring another government bailout. That is, the managers may infer that the government is unlikely to impose a fine of more than $2 billion, regardless of the corporation's crimes.

From a coldly "rational" perspective, the managers would determine that undertaking the illegal transactions would yield a marginal profit of $500 million and incur a risk-adjusted prosecutorial fine of $200 million. (15) In this circumstance, if a corporate fine is all the bank managers really have to fear, then even from the bank's perspective this transaction with an expected profit of $300 million would be rational. And if the bank's compensation structure means the managers will get bonuses for generating the extra profit, all the more reason to break the law. Of course, this calculus only holds if the managers have no personal fear of imprisonment. Given this, prosecutors investigating this bank should not expect corporate fines alone to deter this kind of crime.

This Note's novel microeconomic model integrates the TBTJ problem into the economic analysis of corporate crime and suggests how prosecutorial strategy ought to change in response to this powerful, often binding, constraint on the government's ability to sanction a guilty company. While several similar and well-established microeconomic models of corporate criminal liability argue that it is possible to optimally deter corporate crime by...

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