Corporate fraud demands criminal time

We're now getting an idea of just how expensive breaking the law can be. Ten years after Volkswagen executives first decided to cheat emissions tests on some of their diesel models, the company has agreed to pay almost US$15 billion (S$20 billion) to settle claims in the United States.

Volkswagen still faces state and federal criminal investigations in the US and more around the world, sales of VW cars have collapsed, and the company's once-sterling reputation has been forever tarnished.

So given the result, why did company executives decide to cheat and what can that tell us about preventing corporate crime in the future?

These are not academic questions. The absence of reliable data makes it difficult to pin down the precise impact of corporate fraud. One recent analysis estimated the annual costs in the US of just one kind of white-collar crime - corporate securities fraud - at US$380 billion.

Fortunately, research on street crime gives us some ideas about corporate crime. There are two fundamental dimensions of deterrence: the certainty of punishment and the severity of punishment. Basically, will I be caught and, if so, how badly will I be punished?

Research on street criminals shows that the first dimension - certainty of apprehension - has a stronger deterrent effect. The more people think they will be arrested for a crime, the less likely they are to commit it.

VW's decision to cheat was based in part on the assumption that the likelihood of getting caught was very low. Certainly, the company had little reason to fear discovery in the US, where government regulators have been slow to react to suspected design defects, going back to the infamous exploding Ford Pintos of the 1970s.

And it was relatively easy to fool the Environmental Protection Agency emissions tests, which take place in a lab. The company's deception was discovered only by chance when a non-profit organisation called the International Council on Clean Transportation gave a grant to researchers from West Virginia University to test emissions when the cars were on the road.

The second dimension of deterrence is severity of punishment. Here again, Volkswagen believed it had little to fear. As late as last year, after the US authorities had begun to investigate, the company "was advised", it explained to shareholders, that the record fine for emissions tampering was only US$100 million.

But the likelihood of a long sentence or big fine is far less of a deterrent than the likelihood of being caught in the first place. On Wall Street, federal prosecutors have recently relied heavily on deferred prosecution agreements with financial firms like HSBC and Barclays. The companies agreed to stop their illegal conduct for a certain time, after which no criminal charges would be filed.

The deterrent value of these types of punishments, however, is highly questionable. A 2011 analysis by The New York Times found that many Wall Street firms charged with securities fraud in a 15-year period were "repeat offenders" that continued to break the rules even though they faced heavier penalties.

If we are serious about preventing corporate crime, we must change the corporate calculus. First, we need to increase the chances that white-collar criminals will be punished. One approach is an "enforcement pyramid" in which corporate infractions are met with graduated responses that start with education and end, if necessary, with prosecution.

Second, corporate executives must face the very real prospect of doing time in prison and not just pay fines. Judges have handed out very long sentences in well-publicised cases - Bernie Madoff and Jeff Skilling of Enron, for example. But these few severe penalties are not nearly as effective a deterrent as imposing relatively short prison sentences on a much larger number of white-collar defendants.

Third, regulatory agencies must also have a stronger presence in the markets and industries they oversee. As noted Carnegie Mellon criminologist Daniel S. Nagin put it, "an idling police car outside a liquor store greatly reduces the chance, probably to zero, that the store can be successfully robbed".

Yet despite all that criminologists know about the consequences of taking the police off the white-collar beat, governments continue to cut the staffing of regulatory and law enforcement agencies.

For example, from 2001 to 2008, the number of agents at the Federal Bureau of Investigation conducting white-collar crime inquiries declined by 36 per cent. It is no coincidence that by last year, federal white-collar prosecutions were at their lowest level in 20 years, even in the wake of a major economic crisis believed by many to have been fuelled by fraud.

Theories of deterrence are based on a simple idea: that criminals, either individuals or corporations, behave rationally, weighing their actions against possible gains and consequences.

To stop crime, we need to tip that calculation in society's favour. Mr Phil Angelides, the former chairman of the Financial Crisis Inquiry Commission, which examined the causes of the 2008 financial collapse, said the relatively small fines paid by corporations are "akin to someone who robs a 7-Eleven, takes $1,000 and being able to settle for $25 and no admission of wrongdoing".

He added: "Will they do it again? Absolutely, because it pays."

NEW YORK TIMES


  • Robert H. Tillman, a sociologist at St. John's University, and Henry N.Pontell, a criminologist at John Jay College of Criminal Justice, are authors (with Stephen M. Rosoff) of Profit Without Honour: White-Collar Crime And The Looting Of America.
A version of this article appeared in the print edition of The Straits Times on July 05, 2016, with the headline 'Corporate fraud demands criminal time'. Print Edition | Subscribe