Speaker: Brandon L. Garrett, Professor of Law, University of Virginia
Chair: Stewart Fleming, Senior Member, St. Antony’s College, University of Oxford
There are several tools for improving conduct in the financial industry: addressing culture and ethics, improving supervisory oversight, tightening regulation. But when a pattern of misconduct has occurred, it becomes time for law enforcement to step in.
Over the last years there have been high profiles cases of investigations and prosecutions into criminal misconduct by banks. This has been most frequent in the US, leading the Financial Times to dub the American Department of Justice “the harshest prosecutor of corporate offences in the world”.
Yet all is often not as it seems with these high-profile cases and penalties, as Brandon Garrett, Professor of Law at the University of Virginia, explained at a PEFM seminar in early June. Garrett recently published a book on the matter, Too Big to Jail: How Prosecutors Compromise with Corporations.
In an increasing number of cases, US prosecutors are not indicting and convicting corporations of the crimes they admit to committing. Instead, banks and prosecutors enter into agreements that avoid a conviction and criminal sentencing, in exchange for the corporations complying with certain conditions.
These agreements are called deferred- or non-prosecution agreements. Originally introduced as a way of rehabilitating small-time drug offenders in the 1930s, these agreements gained newfound popularity for corporate crimes after a high-profile 2002 case against the accounting firm Arthur Andersen, associated with the Enron scandal, led to its dissolution.
The Arthur Andersen case seemingly illustrated the adverse consequences of corporate prosecution on blameless employees, now laid off, and knock-on effects in the economy. Prosecutors turned to deferred prosecution agreements as a means of aiming to reform corporate governance flaws and imposing penalties without the possible adverse effects associated with a guilty sentence. Without a guilty sentence, banks aren’t at risk of having their licenses revoked and being driven out of business.
But can such agreements address the root causes of misconduct, having the rehabilitating effect that they were once intended to have on drug offenders? They can impose hefty penalties: the HSBC deferred prosecution agreement included a $1.256 billion criminal forfeiture.
They also allow prosecutors to marshal the resources of the banks themselves to enforce reforms. Garrett pointed out that the resources of banks astronomically outstrip those of regulators and prosecutors alike. The agreements can require banks to put money aside in order to boost compliance departments or instate a monitor to issue independent reports on developments in the banks’ conduct.
One such high profile monitor was Michael Cherkasky, a former New York prosecutor, appointed to oversee HSBC’s anti-money laundering reform efforts. The actual influence of such monitors is not yet clear; Cherkasky’s most recent report highlighted resistance to reforms by ‘combative’ senior managers at the bank.
As Garrett pointed out in his seminar, corporate governance reform efforts through these agreements are difficult also because there is no ready blueprint for good corporate governance. In fact, regulators’ checklist approach was often what led them to miss patterns of fraud or abuse. The reform requirements agreed by prosecutors and banks may be blunt instruments for rectifying cultures of criminal behavior.
It is also striking that deferred prosecution agreements have not been used to prosecute more individuals responsible for the crimes. Garrett argued that prosecutors could make much greater use of the banks’ cooperation required by the agreements to build cases against particular individuals. The agreements will often include sufficient information to identify those personally culpable for the misconduct, but will avoid naming them.
Garrett argued that judges should more active in monitoring and overseeing these deferred prosecution agreements. After all, they effectively entail judges agreeing to delay and ultimately suspend an indictment when there is evidence that crimes have been committed.
The recent suspension of UBS’ non-prosecution agreement suggests that adherence to conditions is being taken seriously; banks are not guaranteed a free ride if they reach an agreement. But Garrett is right to point to the greater responsibility that judges can take in scrutinizing and approving agreements that allow banks to avoid a guilty plea.
However, the very concept of deferred prosecution agreements has come under fire. US senator Elizabeth Warren has criticized the practice, arguing that prosecutors are too lenient on corporate criminals. Indeed, prosecutors should consider carefully whether the benefits of banks’ cooperation and the possible costs to the economy of conviction are so great as to warrant avoiding indictment. Otherwise ‘too big to jail’ will do little to rehabilitate, and instead foster moral hazard and further bad behavior.
Others have criticized the opacity of some of the agreements, at least as regards the evidence that underlay the decision to agree a deal rather than go to court. Moreover, although there are guidelines for the size of penalties, the discretion afforded the prosecutors and the above opacity has often led to the size of the fines sometimes appearing to have little logic. Garrett’s own analysis indicated that being a foreign company, for example, has been a key factor in determining the size of fines, even after correcting (to the extent known) for the nature of the misdemeanor and its severity. But arbitrary or not, fines have been growing in size across the board and are undoubtedly concentrating minds in the corporate world.