Entity-level fines may not adequately deter corporate crime compared to other enforcement mechanisms.
For many years, law and economics scholars, as well as politicians and regulators, have debated whether corporate criminal enforcement deters too much beneficial corporate activity or lets corporate criminals off too easily.
This debate has recently grown more polarized. On the one hand, academics, judges, and politicians have excoriated enforcement agencies for failing to send individual bankers to jail in the wake of the financial crisis. On the other hand, the U.S. Department of Justice has since relaxed policies aimed at holding individuals liable and reduced the size of fines imposed on corporations.
A crucial, and yet understudied, piece of evidence in this conversation is how federal enforcement has affected crime. Unlike every other type of crime, the government does not collect data about corporate crime levels. As a result, we cannot tell how corporations are responding to the Justice Department’s changed enforcement practices.
In a recent paper, “The Cost of Doing Business: Corporate Crime and Punishment Post-Crisis,” we take important first steps in determining how corporations are responding to the federal enforcement regime in the United States and its shifting priorities. In our analysis, we focus on financial institutions, and use three novel sources as proxies for corporate crime: the Financial Crimes Enforcement Network Suspicious Activity Reports (SARs), consumer complaints made to the Consumer Financial Protection Bureau (CFPB), and whistleblower complaints made to the U.S. Securities and Exchange Commission (SEC).
These proxies for misconduct are imperfect. But given the substantial data limitations in this field, they are useful in helping to identify trends in criminal activity. SARs are required to be filed by financial institutions under certain circumstances that are highly suggestive of malfeasance, while the CFPB data are generated by aggrieved consumers of financial products. Whistleblower complaints are generally filed by employees of banks and companies who suspect that corporate crime has occurred; if the information leads to a successful enforcement action, the whistleblower is eligible for a large bounty.
Based on data for the period 2012 to 2019, we document an upward trend in SARs filed across every agency that collects them: the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the National Credit Union Administration, the Federal Reserve Bank, the Internal Revenue Service, and the SEC. This means that financial institutions flagged a greater number of transactions suggestive of money laundering, fraud, or other financial crimes in each year for the past five years. In addition, we document an upward trend in consumer complaints about financial misconduct submitted to the CFPB from November 2014 to August 2019. Finally, we observe a steady increase in whistleblower tips submitted to the SEC from 2011 to 2018. In sum, our data suggest an upward trend in reports of corporate misconduct coming from three unrelated sources.
We also examine levels of public company recidivism, which are also on the rise. And we document a striking relationship: Recidivist companies are much larger than non-recidivist companies, but they receive smaller fines than non-recidivist companies when measured as a percentage of assets and revenue. In theory, high fines can supply adequate deterrence by themselves, but our results indicate that it might not be politically feasible or legally possible to levy a sufficiently high fine to deter future incidents of corporate crime. For large companies, criminal penalties may be just another cost of doing business—and a reasonable cost at that.
In addition, the ultimate deterrent effect of fines against corporations and their shareholders may be muted by several factors. For one, there is a disconnect between the recipient of the punishment and the bad actor when the only punishment is an entity-level fine. An entity-level fine primarily affects shareholders, not necessarily the individuals who committed or even benefitted from the crime. In theory, shareholders should have an incentive to take steps to deter criminal activity, but rationally apathetic shareholders might not recognize the problem nor understand how to address it. In addition, although a company’s stock price falls after the imposition of the penalty, it usually bounces back very quickly. Consequently, shareholders might not demand an appropriate reduction in activity levels, or the right amount of firm-wide monitoring, to avoid future instances of crime.
In sum, we theorize that an over-reliance on entity-level fines is likely inadequate from a deterrence perspective. Even though the average fine is higher today than ever before, fines are still too low to make up for uneven enforcement. The optimal entity-level penalty is likely to be very large and potentially infinite—well beyond the realm of possibility for those negotiating these settlements. Even if enforcers could levy the optimal fine, the effect would be muted. Dispersed shareholders would bear the brunt of the harm, but collective action problems limit their ability to discipline wayward management. In other words, the managers who agree to pay fines out of shareholders’ pockets might not bear any consequences.
We recognize, however, that our data do not allow us to identify precisely the aspects of our enforcement regime that are failing us or the appropriate course of action to correct them. Our principal policy recommendation is for the government to treat corporate crime like any other type of crime and measure it. With better data, policymakers would be better positioned to calibrate enforcement to deter corporate misconduct. If, however, our results are confirmed with further study, the normative implications seem to be clear. To increase deterrence, enforcement agencies should look for other ways to deter corporate misconduct, including by pursuing culpable individuals.