Monday, October 23, 2006

Commentary on Skilling

Commentary on Jeffrey Skilling's sentence of 24 + years (292 months) by Peter & Ellen -

Will we ever see sentences like these again?

Peter - The collapse of Enron, WorldCom, and Adelphia Communications due to large-scale accounting fraud was, in many ways, unprecedented, the "perfect storm" so to speak. Executives have never been sentenced to such substantial terms before, and I doubt we will see these types of sentences again. Not because corporate crime will cease, but because the ability to engage in these types of accounting tricks is now much more difficult. For one thing, the accountants and the lawyers are paying much more attention to the details, in part because of Sarbanes-Oxley but perhaps even more because the job of those professions is more directed toward policing management. Rogue executives can still engage in criminal conduct, but I would be very surprised if we saw the type of brazen accounting fraud perpetrated by WorldCom. There will be another cycle of corporate misconduct, and I don't think anyone can predict where it will strike. But like the S&L crisis of the 1990s, it is unlikely to be spread across industries and involve conduct at major enterprises. I don't think we'll see another Bernie Ebbers or Jeffrey Skilling on trial for destroying a company, in effect, so corporate crime prosecutions will be for more isolated misconduct. Not that corporate executives should forget these sentences, but they are not at risk of suffering them because at least for the foreseeable future the types of crimes that Ebbers and Skilling engaged in are not going to take place.

Ellen -  I also rather doubt we will see sentences like this again, but not because the Enron & Worldcom wave are over or because Sarbanes -Oxley is going to solve the problem.  There have always been corporate fraud scandals and there will likely be scandals down the road.  Just as we saw new frauds developed throughout our past history, most likely we will see new forms of fraud in the future.  What they will be, and how extensive they will be, remains to be seen. And just as Congress reacted to the scandals of today with new legislation (Sarbanes-Oxley) so too will we find reactive legislation passed in the future to handle the new types of criminality that appears on the scene.

But I don't think we will see sentences like this in the future because people will eventually realize the worthlessness of issuing such draconian sentences in non-violent white collar cases.  The bottom line is that these sentences are not likely to deter future criminality, as many who engaged in the conduct just did not see themselves as committing crimes.  Jeff Skilling's claim of innocence, even at his sentencing, is a statement that in order to deter criminality we need to start teaching law in business schools so that those going into the business world are fully apprised of where the line is between acceptable business practices and criminal conduct.   

Do these sentences match the harm in other white collar crime cases?

Peter -While Jeffrey Skilling receives 24 years for presiding over the collapse of Enron, former Congressman Randy (Duke) Cunningham sells his office to a string of defense contractors for a bit over $1 million and receives a sentence of 8 years. Soon-to-be former Congressman Bob Ney will likely be sentenced to less than 3 years in prison for selling out his office to lobbyists led by Jack Abramoff. How can there be such a disparity between the sentences for public corruption and the corporate frauds perpetrated by Ebbers and Skilling? The harm from public officials, especially those elected to office, who abuse their positions for personal gain is, in my opinion, nearly as great as that caused by corporate chieftains who preside over collapsing companies. While one might argue that it is wrong to "criminalize agency costs" by prosecuting corporate officers, we never hear that argument applied to public corruption. The sentences in those cases need to be increased significantly to send an even stronger message to public officials that selling their offices, and the public's trust, is intolerable. Investors don't lose pensions, but the harm is just as great, I believe.

Ellen -  I agree that in recent cases we see lighter sentences in corruption cases than we see in the corporate sphere and that this disparity is not warranted. If anything, having the public's trust should be considered a greater threat to society than criminal activity in the private sphere.  But I do disagree that this warrants increasing the sentences in corruption cases.  More appropriately, this sends the message that recent corporate sentences are not aligned with reality. Sending non-violent offenders to prison for life sentences serves no utilitarian purpose.  Sending a person to prison for 25 years as opposed to 10 years for a corporate crime does not offer increased rehabilitation to the individual. After all this person will never be in this position again to commit a like crime. It also serves no deterrent if the individual has no recognition of what is legal and what is illegal.  Further, a 10 year sentence would send an equally strong message to anyone entering the corporate world that they need to act properly.  The only purpose here is retribution.  And the shame of this conviction, a sentence of 10 years, and the collateral consequences faced by the white collar offender easily send that same message.

If we are so intent on punishing the wrongdoer with heavy prison time, then how can we accept Andrew Fastow being sentenced to 6 years, or Scott Sullivan receiving 1/5 of the sentence received by Bernie Ebbers.  It becomes clear that what we are really doing here is punishing individuals who exercise their right to a jury trial. And permitting the government to continue this practice is not proper.


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I agree that the government is penalizing people who refuse to plead guilty and stand trial. It has done this for a long time. I do not agree that Skilling did nothing, or violated no laws (as Tom Kirkendell suggests). I think it clear that he and Lay lied to investors about Enron's state of affairs. That said, 24 years is a long sentence for someone who didn't personally profit from his crime (he was acquitted of insider trading, remember).

Posted by: Christopher Cooke | Oct 23, 2006 7:51:37 PM

As always you nicely lay out your positions. I hope that in fact the corporate world has abandoned its outlaw accounting mentality. The criminal prosecutions, I think are unfortunate in that they distract us from the cause. As I see it the cause of the financial trouble of so many firms was a change in the legal environment. The accountants in 1994 were relieved by the Supreme Court from the risk of being found aiding & abetting fraud. They were relieved from federal joint & several liability in 1995 by congress. Also, the risk of losing a fedreral class action lawsuit was greatly diminished by the same Tort Reform Act of 1995. Starting in 1995, financial restatements soared, because managing earnings (cooking the books) became an accepted practice; it was broadly practiced in some cases resulting in insolvencies but in all cases investors lost billions. Although, they were primary in the corruption corporate officers could not have done it without the cooperation of accountants, lawyers, bankers, & brokers. We need to assure the public that financial statements are reliable and not cooked. Internal controls are essential. CEOs & CFOs should continue to be held accountable for establishing & maintaining thorough internal controls. I think the repeal of the Private Securities Litigation Act of 1995 would be the most certain way of restoring the high standards that were abandoned after that deregulatory act.

Posted by: Ronald X. Groeber, Ball State Univ | Oct 24, 2006 9:13:07 PM

I am not sure that repealing the Private Securities Litigation Reform act will do much but ensure a transfer of dollars from the insurance companies who undwrite the D&O policies issued to public companies, to the Lerach Stoia firm and the remants of Milberg Weiss. However, I agree that auditors should not have been given the break that they were (in Central Bank and PSLRA).

If Mr. Groeber's thesis were correct, we should have had very few accounting frauds in Silicon Valley during the 1990s, when the accounting firms were on the hook (up to 1994) as aiders and abetters, in civil shareholder suits. However, I cannot say that was correct. There were several big scandals in Silicon Valley pre-dating Central Bank (Media Vision, Cal Micro Devices, Technical Equities). And, while the numbers of scandals increased after Central Bank, I think there were a confluence of reasons for this unrelated to changes in the law brought about by Central Bank and the PSLRA.

I used to investigate many of these companies during the 1990s and 2000s, while an attorney at the SEC in San Francisco. It appeared to me that most of the restatements and accounting scandals of the late 1990s/early 2000s were a result of (1) the dot com and stock market bubbles, and desires of some companies to show growth in revenue to keep up with their peers; (2) auditors using audit practice as a "loss leader" to attract much more lucrative consulting business, and their concern about losing the "cash cow" of consulting if they came down too hard on their audit clients; and (3) managements' obsession with stock performance, due to the use of stock options as compensation (such much of exec compensation depended on the stock price) and accounting rules that didn't require companies to expense such options issuance as compensation. I think SOX took care of (2) and (3), and the market correction took care of (1).

That is not to say that fraud won't continue to occur, but if it does, it will be for other reasons. But, I have found, since Arthur Andersen's demise, especially, that the auditors are doing a much better job.

Posted by: Christopher Cooke | Oct 26, 2006 3:18:58 PM

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