The Limits of Individual Prosecutions in Deterring Corporate Fraud

One must search long and hard to find an academic, journalist, politician, or citizen who does not believe that the best tool for deterring corporate crime is criminal prosecution of individual employees, especially managers.  Even the Justice Department’s oft-maligned program for negotiated settlements with offending companies prioritizes leveraging corporate criminal liability to produce otherwise elusive evidence of individual violations, to assist in visibly and reliably imposing criminal sanctions, especially prison, on natural persons.

The enduring and growing commitment to this view is not surprising.  For decades, deterrence theory has supported the idea that credibly threatening individuals with criminal prosecution is essential because people, not firms, commit corporate crimes and corporations cannot be imprisoned.  Moreover, it is commonly believed that the catastrophic effects of individual felony conviction, even when accompanied by a modest prison sentence, are especially frightening to economically motivated offenders operating within reputable businesses.

Rates of offending for financial fraud, bribery, insider trading, and like offenses are not observable.  It thus cannot be estimated to what extent, and under what conditions, individual prosecutions deter corporate crime.  But it is hard to argue with the powerful intuition that executives will fear prison much more than individual civil sanctions or even severe criminal sanctions imposed on their employer.  At a minimum, behavioral science has shown that the prospect of criminal sanctions will more potently influence individuals as the probability of such sanctions rises.  Theory supports the urge to indict more individuals, make cases visible across a variety of industries, and show that courts will impose meaningful prison sentences.

In a new paper forthcoming in the Wake Forest Law Review, The Limits of Individual Prosecutions in Deterring Corporate Fraud, I use litigation evidence to show that this prevailing view, and the model of deterrence on which it is based, is both too simplistic and too optimistic.  Contrary to the common perception that the Justice Department has failed to prosecute when it matters most, including in the wake of the financial crisis of 2008, federal prosecutors (and their counterparts in the United Kingdom) have brought dozens of cases over the last decade and a half in major corporate sectors, especially the financial industry.  Those cases have included prosecutions for fraud in the dealing of mortgage-backed securities (MBS), as well as prosecutions involving trading fraud in the high profile Libor interest rate and Forex currency derivatives affairs.

What is most notable about these cases is their very high failure rate.  In a federal criminal justice system that produces close to a 100 percent conviction rate, prosecutions involving the most important corporate scandals of recent vintage have produced dreadful results.  The Article considers 60 criminal cases arising from the MBS, Libor, and Forex matters.  It further examines over a dozen prosecutions from major non-finance scandals involving the BP, Volkswagen, GM, and Boeing corporations.  In the finance cases, only 13 sentences that included imprisonment were imposed.  In the non-finance cases only one prison sentence has resulted from over a dozen prosecutions.  (The failure point is mostly in securing and maintaining convictions; sentencing rules for these types of offenses now routinely authorize very long prison terms.)

The empirical approach of the Article is qualitative.  No causal inference is attempted or even possible here.  The objective is to show how and why trial judges, juries, and appellate judges have often rejected the government’s most important cases when those cases involve strong proof and promise significant deterrent effects.  Taking the reader deep into the trial and appellate records of some of these cases—where the literature does not travel often enough–demonstrates why even highly skilled prosecutors have fared so poorly when it has mattered most and their resources were greatest.

The Article’s study shows that applying criminal laws, particularly anti-fraud laws, to lawful economic enterprises that are generally favored raises line-drawing problems that open the way for arguments and doubts of the sorts much more easily surmounted in ordinary criminal litigation.  (Theoretically and doctrinally, I have addressed this problem here, here, and here.)  Moreover, to prove corporate crime, prosecutors usually need to start with individuals at the working level, where actus reus and mens rea can often be proven through documents and conduct. Jurors and judges, who are directed to focus on the individual defendant sitting before them, are open to the idea that lower-level actors were “just doing their job” or were “scapegoats” for management failures or malfeasance. These obstacles grow continuously as the scale of firms expands and their activities cross legal systems, economies, and cultures.  (Set aside the one-person fraud bands like Madoff, Holmes, and Bankman-Fried: crimes in large, mature corporations tend to be much more challenging to deal with than Ponzi or Ponzi-adjacent schemes hatched by founders.)

Of course, I do not argue against prosecuting individuals for corporate crime or increasing public resources available for investigation and enforcement in the massive industrial sector.  However, debate about corporate crime has fallen into a rut of urging more indictments of individuals without appreciating that the limitations of that strategy extend far beyond the government’s capacity and willingness to charge.

In light of its findings, the Article considers the relative prospects of alternative measures for addressing corporate crime that receive attention but still not nearly enough.  These measures include civil enforcement mechanisms better designed to deter and whistleblower and compliance systems more effective at uncovering violations.  Above all, the field should refocus its attention on the relationship between regulation and corporate crime.  More effective regulation and regulatory enforcement that prevents criminal misconduct, or at least makes it far less appealing to corporate personnel, and is based on industry-specific wisdom, would be preferable to continuing to expect generalist federal prosecutors to respond to every new problem, ex post, with corporate settlements and indictments of individuals that, it turns out, do not reliably produce convictions.

The regulatory problem is even deeper.  In future work, I will explore what might be called (pardon the jargon) the criminogenic capacity of regulation.  Ineffective regulation can not only fail to prevent corporate crime, it causes it.  For those kind enough to read the paper, you might notice that virtually every corporate crime the Article discusses was conceived by its creators out of the very public regulatory, self-regulatory, or internal compliance system that was designed to prevent the misconduct.  To address a problem one must understand its sources.  Lack of large, meaningful data prevents rigorous causal inference in this area.  Nonetheless, there is a resource that can tell us much about the causes of corporate crime:  the rich litigation records that are left behind when the government does pursue individual prosecutions to trial and beyond.