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S. HRG. 107–923

PENALTIES FOR WHITE COLLAR CRIME

HEARINGS

BEFORE THE

SUBCOMMITTEE ON CRIME AND DRUGS

OF THE

COMMITTEE ON THE JUDICIARY

UNITED STATES SENATE

ONE HUNDRED SEVENTH CONGRESS

SECOND SESSION

JUNE 19, JULY 10, AND JULY 24, 2002

Serial No. J–107–87

Printed for the use of the Committee on the Judiciary

(
(II)

COMMITTEE ON THE JUDICIARY

PATRICK J. LEAHY, Vermont, Chairman

EDWARD M. KENNEDY, Massachusetts

JOSEPH R. BIDEN, JR., Delaware

HERBERT KOHL, Wisconsin

DIANNE FEINSTEIN, California

RUSSELL D. FEINGOLD, Wisconsin

CHARLES E. SCHUMER, New York

RICHARD J. DURBIN, Illinois

MARIA CANTWELL, Washington

JOHN EDWARDS, North Carolina

ORRIN G. HATCH, Utah

STROM THURMOND, South Carolina

CHARLES E. GRASSLEY, Iowa

ARLEN SPECTER, Pennsylvania

JON KYL, Arizona

MIKE DEWINE, Ohio

JEFF SESSIONS, Alabama

SAM BROWNBACK, Kansas

MITCH MCCONNELL, Kentucky

BRUCE A. COHEN, Majority Chief Counsel and Staff Director

SHARON PROST, Minority Chief Counsel

MAKAN DELRAHIM, Minority Staff Director

SUBCOMMITTEE ON CRIME AND DRUGS

JOSEPH R. BIDEN, JR., Delaware, Chairman

PATRICK J. LEAHY, Vermont

DIANNE FEINSTEIN, California

HERBERT KOHL, Wisconsin

RICHARD J. DURBIN, Illinois

MARIA CANTWELL, Washington

JOHN EDWARDS, North Carolina

CHARLES E. GRASSLEY, Iowa

ORRIN G. HATCH, Utah

MIKE DEWINE, Ohio

JEFF SESSIONS, Alabama

SAM BROWNBACK, Kansas

MITCH MCCONNELL, Kentucky

GEORGE ELLARD, Majority Chief Counsel

RITA LARI, Minority Chief Counsel
(III)

C O N T E N T S

WEDNESDAY, JUNE 19, 2002

STATEMENTS OF COMMITTEE MEMBERS

Page

Biden, Hon. Joseph R., Jr., a U.S. Senator from the State of Delaware ............. 1

Grassley, Hon. Charles E., a U.S. Senator from the State of Iowa, prepared

statement .............................................................................................................. 129

Hatch, Hon. Orrin G., a U.S. Senator from the State of Utah, prepared

statement .............................................................................................................. 135

Leahy, Hon. Patrick J., a U.S. Senator from the State of Vermont, prepared

statement and attachments ................................................................................. 136

WITNESSES

Bowman, Frank O., III, Associate Professor of Law, Indiana University School

of Law, Indianapolis, Indiana ............................................................................. 23

Comey, Hon. James B., Jr., United States Attorney, Southern District of

New York, New York, New York ........................................................................ 18

Deputy, Howard, Smyrna, Delaware ..................................................................... 12

Farmer, Janice, Orlando, Florida, accompanied by Jeffrey Farmer .................... 9

Gainer, Hon. Glen B., III, West Virginia State Auditor, and Chairman, National White Collar Crime Center, Morgantown, West Virginia ...................... 20

Prestwood, Charles, Conroe, Texas ........................................................................ 5

Rosenzweig, Paul, Senior Legal Research Fellow, Center for Legal and Judicial Studies, Heritage Foundation, Washington, D.C. ...................................... 26

Skolnik, Hon. Bradley W., Indiana Securities Commissioner, and Chairman,

Enforcement Section, North American Securities Administrators Association, Inc., Washington, D.C. ................................................................................ 21

QUESTIONS AND ANSWERS

Responses of Mr. Bowman to questions submitted by Senators Biden and

Grassley ................................................................................................................ 42

Responses of Mr. Comey to questions submitted by Senators Biden and Grassley .......................................................................................................................... 46

Responses of Mr. Gainer to questions submitted by Senators Biden and

Grassley ................................................................................................................ 62

Responses of Mr. Rosenzweig to questions submitted by Senators Biden and

Grassley ................................................................................................................ 69

Responses of Mr. Skolnik to questions submitted by Senators Biden and

Grassley ................................................................................................................ 75

SUBMISSIONS FOR THE RECORD

Bowman, Frank O., III, Associate Professor of Law, Indiana University School

of Law, Indianapolis, Indiana, prepared statement .......................................... 79

Breaux, Hon. John, a U.S. Senator from the State of Louisiana, statement ..... 95

Comey, Hon. James B., Jr., United States Attorney, Southern District of

New York, New York, New York, prepared statement ..................................... 101

Farmer, Janice, Orlando, Florida, accompanied by Jeffrey Farmer, prepared

statement .............................................................................................................. 119

Gainer, Hon. Glen B., III, West Virginia State Auditor, and Chairman, National White Collar Crime Center, Morgantown, West Virginia, prepared

statement .............................................................................................................. 121

Prestwood, Charles, Conroe, Texas, prepared statement ..................................... 142
Page

IV

Rosenzweig, Paul, Senior Legal Research Fellow, Center for Legal and Judicial Studies, Heritage Foundation, Washington, D.C., prepared statement ... 144

Skolnik, Hon. Bradley W., Indiana Securities Commissioner, and Chairman,

Enforcement Section, North American Securities Administrators Association, Inc., Washington, D.C., prepared statement and attachments ............... 156

WEDNESDAY, JULY 10, 2002

STATEMENTS OF COMMITTEE MEMBERS

Biden, Hon. Joseph R., Jr., a U.S. Senator from the State of Delaware ............. 163

Grassley, Hon. Charles E., a U.S. Senator from the State of Iowa ..................... 165

prepared statement .......................................................................................... 253

Hatch, Hon. Orrin G., a U.S. Senator from the State of Utah, prepared

statement .............................................................................................................. 260

Leahy, Hon. Patrick J., a U.S. Senator from the State of Vermont, prepared

statement .............................................................................................................. 261

Sessions, Hon. Jeff, a U.S. Senator from the State of Alabama .......................... 176

WITNESSES

Chertoff, Michael, Assistant Attorney General, Criminal Division, Department

of Justice, Washington, D.C. and William W. Mercer, United States Attorney for the District of Montana and Chairman, Attorney General’s Advisory

Committee, Subcommittee on Sentencing, Billings, Montana ......................... 167

Coffee, John C., Jr., Adolf A. Berle Professor of Law, Columbia University

School of Law, New York, New York .................................................................. 180

Devine, Tom, Legal Director, Government Accountability Project, Washington,

D.C. ........................................................................................................................ 191

Donaldson, Thomas, Mark O. Winkelman Professor, Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania ............................................. 185

Elson, Charles M., Edgar S. Woolard, Jr. Professor of Corporate Governance,

and Director, Center for Corporate Governance, University of Delaware,

Newark, Delaware ................................................................................................ 187

Terwilliger, George J., III, White and Case, LLP, Washington, D.C. ................. 188

SUBMISSIONS FOR THE RECORD

Biden, Hon. Joseph R., Jr., a U.S. Senator from the State of Delaware,

statement .............................................................................................................. 216

Chertoff, Michael, Assistant Attorney General, Criminal Division, Department

of Justice, Washington, D.C. and William W. Mercer, United States Attorney for the District of Montana and Chairman, Attorney General’s Advisory

Committee, Subcommittee on Sentencing, Billings, Montana, prepared

statement .............................................................................................................. 218

Coffee, John C., Jr., Adolf A. Berle Professor of Law, Columbia University

School of Law, New York, New York, prepared statement .............................. 227

Devine, Tom, Legal Director, Government Accountability Project, Washington,

D.C., prepared statement .................................................................................... 237

Donaldson, Thomas, Mark O. Winkelman Professor, Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania, prepared statement ......... 243

Terwilliger, George J., III, White and Case, LLP, Washington, D.C., prepared

statement .............................................................................................................. 265

WEDNESDAY, JULY 24, 2002

STATEMENTS OF COMMITTEE MEMBERS

Biden, Hon. Joseph R., Jr., a U.S. Senator from the State of Delaware ............. 273

Grassley, Hon. Charles E., a U.S. Senator from the State of Iowa, prepared

statement .............................................................................................................. 304

Hatch, Hon. Orrin G., a U.S. Senator from the State of Utah, prepared

statement .............................................................................................................. 309

WITNESSES

Doty, James R., former General Counsel, Securities and Exchange Commission, and Partner, Baker Botts, LLP, Washington, D.C. .................................. 282
Page

V

Hills, Roderick M., former Chairman, Securities and Exchange Commission,

and Chairman, Hills Enterprises Limited, Washington, D.C. ......................... 280

Miller, G. William, former Secretary of the Treasury, former Chairman of

the Federal Reserve Board, and Chairman, G. William Miller & Co., Inc.,

Washington, D.C. ................................................................................................. 276

SUBMISSIONS FOR THE RECORD

Doty, James R., former General Counsel, Securities and Exchange Commission, and Partner, Baker Botts, LLP, Washington, D.C., prepared statement ...................................................................................................................... 298

Hills, Roderick M., former Chairman, Securities and Exchange Commission,

and Chairman, Hills Enterprises Limited, Washington, D.C., prepared

statement .............................................................................................................. 310

Miller, G. William, former Secretary of the Treasury, former Chairman of

the Federal Reserve Board, and Chairman, G. William Miller & Co., Inc.,

Washington, D.C., prepared statement .............................................................. 327

(1)

PENALTIES FOR WHITE COLLAR CRIME OFFENSES: ARE WE REALLY GETTING TOUGH

ON CRIME?

WEDNESDAY, JUNE 19, 2002

UNITED STATES SENATE,

SUBCOMMITTEE ON CRIME AND DRUGS,

COMMITTEE ON THE JUDICIARY,

Washington, D.C.

The Subcommittee met, pursuant to notice, at 10:44 a.m., in

room SD–226, Dirksen Senate Office Building, Hon. Joseph R.

Biden, Jr., Chairman of the Subcommittee, presiding.

Present: Senator Biden.

OPENING STATEMENT OF HON. JOSEPH R. BIDEN, JR., A U.S.

SENATOR FROM THE STATE OF DELAWARE

Chairman BIDEN. The Subcommittee will come to order, please.

I welcome you all, particularly our witnesses, today.

By way of brief introduction, Senator Grassley is on his way. He

is at another Committee at the moment. He has a keen interest in

the subject we are about to discuss this morning.

I would like to sort of lay out in a very brief opening statement

what we are about this morning, what I am trying to do, why I am

holding this hearing, and why Senator Grassley and I have the interest we have.

To state the obvious, there is not a single member of the United

States Congress who does not have his or her constituents upset

about not merely Enron but what is raised as a consequence of

Enron—the loss of pensions, the loss of their security, and in a

sense, in the minds of many, the loss of everything they have built

in their whole lives, and what can we do about that.

There is also a larger issue. When I was Chairman of the full Judiciary Committee for years, and the ranking member for even

longer, I spent a lot of time dealing with the criminal justice system and am responsible for or to blame for much of the criminal

law that has been written since 1978 in the United States Congress.

One of the things that we know is that white collar crime can

be equally as devastating as other types of crime. We also know,

though, that it is much more difficult for prosecutors to bring white

collar crime cases. The fact of the matter is we are very, very concerned, and first and foremost concerned about violent crime in

America. But when we get beyond violent crime, we sometimes
2

tend to lose the differentiation that is needed between the impact

of white collar crime and simple theft.

All you have to do in any society is look at their criminal code

and it will tell you what they value and it will tell you how highly

they value it. In America, we value life more than anything else,

so obviously if someone wrongfully takes another person’s life, maliciously and with premeditation takes someone else’s life, we have

the death penalty in most places for that. Evidence the fact we hold

that as the highest value—human life.

If a women is raped, we hold that as a very high value in most

States and we say there will be a severe penalty for that. If someone were to sneak into your house and steal $5,000, it is less of

a penalty than if someone accosts you in the street at gunpoint and

takes $5,000, because they have put you in fear and we value our

right to be free of fear. So we have a higher penalty for robbery

than we do for burglary.

Now, I know this is self-evident when I say it, but I think sometimes we forget it. But the strange thing is when it comes to those

who rob us with a pen, rob us with a pencil, rob us with their financial shenanigans, or they steal from us, to be more precise, they

tend to go to jail less than someone who would steal the same

amount of money from us in a circumstance where they broke into

our house.

The person who breaks into our house and steals $50,000 from

us, or if they could steal our future by stealing our pension, should

go to jail for a long, long time. Yet, white collar crime in most

States and in the Federal Government generally does not carry the

same penalty.

A very slight digression. There are those who are concerned in

the corporate community with the notion of we shouldn’t have tort

reform because stockholders should not be held accountable for the

misdeeds of their companies in a way that causes hundreds of millions of dollars in damages.

Well, I would suggest that we can have it one of two ways. You

can have the tort system the way it is or a criminal system where

we lock those guys up who make those mistakes; no fiduciary burden placed upon any stockholder, but the man or woman goes to

jail. Kind of a good idea, for you folks with bow ties on out there.

It is a good idea for you all to think about, all those of you, like

me, in suits that cost more than $100 who are sitting out front.

The second point I want to make here is that this is about values. So our Criminal Code, which I have not been the custodian of,

but as one who has been an overseer of for some time, 30 years in

the United States Senate, I think has to be adjusted, or we should

consider whether it needs to be adjusted to reflect what we value.

That is what this hearing is about.

Now, I want to make it clear. Our first panel here are people

who, in varying degrees, have had their future stolen from them,

not merely their money, their future stolen from them. One of the

witnesses is a person who is not sure what has been denied him,

but let me make it clear there is no proof of any criminal activity

or intent on the part of either the companies whose pensions have

gone up in smoke for their employees, either Metachem, which Mr.

Deputy worked for, or Enron for our two other witnesses.
3

The reason for the first panel—and it goes back to this value

piece—is for us to understand what the damages are to people who

have lost their pension, if there later is proof that there was a

criminal intent related to their loss. It is a different standard if

there is negligence, and that is a different issue. That is the civil

system.

So I want to make it clear that by having the three people we

have here today, the purpose is not to make a case that either

Enron or Metachem or any other corporation has, in fact, violated

criminal law. They may have. I don’t know, but that is not the

premise upon which you have been invited here.

You have been invited here, just as we would and have invited

victims of rape, victims of burglary, victims of robbery, victims of

senior fraud, to explain to us what the consequences of losing your

future, if you will, has meant to you.

Now, one other point. We are going to have a series of experts

to follow this panel, and I am looking to them to tell me if this discrepancy or the difference between the penalties that flow from

white collar crime generically and other crime generically should

remain, to the extent they exist. And if they exist and they

shouldn’t remain, why do they exist in the first place?

We have to look at this. We have to look at whether the reason

why there are not more prosecutions for white collar crime is because it is much more difficult. By the way, it is much more difficult. Do we have enough trained prosecutors to be able to handle

these very complicated cases?

If it turns out that we should, in fact, be pursuing more white

collar criminals and we are not and we agree that we should, then

we have to figure out why we are not. If one of the reasons we are

not is we don’t have sufficient resources, we don’t have enough

prosecutors, we don’t have enough judges, whatever it happens to

be, then we should remedy that. That is my job, that is the job of

the people up here.

Lastly, I would point out that there has been, in my view, some

progress made by the Sentencing Commission. I am often reminded

that the reason it exists is I wrote the law setting it up, and so

those who dislike it very much usually remind me of that. But I

think they have done a good thing here. I am not sure, quite frankly, and I am going to ask the second panel, if they have gone far

enough.

In the past, the way we have dealt with the calculation of a loss

is the penalty would flow from the calculation. You steal one dollar,

the penalty is less than if you steal one million dollars. The way

we have calculated the loss in the past has been different than is

now being proposed.

In the past, the way in which we have operated is that loss not

only measures the harm wrought, but also an acceptable proxy for

the defendant’s state of mind. Stealing more is worse than stealing

less not only because it inflicts greater harm, but also because the

defendant who steals more is often thought to have a more reprehensible state of mind than the defendant who steals little.

The new guidelines incorporate a much better definition of loss

that takes into account the amount of harm caused by the conduct.

Actual loss now means, quote, ‘‘The reasonably foreseeable pecu-
4

niary harm that resulted from the offense.’’ This definition, in my

view, strikes the right balance between the objective ‘‘but for’’

standard and the subjective inquiry into the defendant’s intentions.

But it still leaves some questions, in my view. The commission

determined that loss should be reduced by the money returned, the

fair market value of the property returned and the services returned by the defendant. With respect to investment fraud cases,

the new guidelines provide that ‘‘loss shall not be reduced by the

money or value of the property transferred to any individual investor in the scheme in excess of the investor’s principal investment.’’

Well, I am not sure that should be the standard, but I want to discuss that.

So we are going to essentially bifurcate this hearing. Again, the

first part of the hearing relates to examples of the impact of loss

of an instrument and/or a thing of value because of fraud. So today

we want to hear from the witnesses as to what they know the impact has been on their lives.

I am delighted to introduce Charles Prestwood, who has traveled

quite a ways from Texas to join us here today. Mr. Prestwood spent

33 1⁄2 years at the Bammel, Texas, gas storage facility, which later

became part of Enron, working his way up from Maintenance to

Operations.

Generally he would work 12-hour shifts, commuting 75-mile

round-trips from his home in Conroe, Texas. Having been very

proud to be part of building Enron into a powerful corporation,

with the encouragement of the company’s top brass he invested an

abundance of his earnings in Enron stock, amassing at its peak

$1.3 million worth of worth.

Like other employees, he was prevented from selling his investments when the company stock value dropped last fall, and in the

end his savings dwindled to a mere $8,000. Not only will he not

be able to spend his retirement traveling, as he had dreamed, but

he now lives in fear that if the furnace or the microwave breaks

down, it is a cost and it is serious.

Ms. Farmer, thank you for traveling from Florida to join us

today. Your son is with you. I indicated to you I know we don’t salute sergeants, but since they run the show, we show them great

respect

Sergeant, it is a delight to have you here, and it looks like you

have someone looking out for you, mom.

Janice Farmer spent 16 years working to build the Enron Corporation, spending the bulk of her tenure in the Right-of–Way Department. After having been encouraged throughout her career to

invest in Enron stock, she was prevented from selling her holdings,

as well, as the market value plummeted. In turn, she saw her savings drop from $700,000 to $4,000.

Is that correct? Why don’t you speak up and tell me what it is?

Ms. FARMER. Twenty.

Chairman BIDEN. Twenty. I am sorry. I devalued your stock even

more. I am sorry.

While she once dreamed of using her savings to take her children

and grandchildren on trips around the globe, she is now at home

and that dream is somewhat distant now. Accompanying her is her
5

son, Jeffrey, a criminal investigator in the Marine Corps. Today, by

the way, is his birthday and I wish him a happy birthday.

While I regret the circumstances that brought you both here, I

want to thank you for joining us.

From my home State, I am pleased to welcome Mr. Howard Deputy. He hails from the State of Delaware. He lives in Smyrna,

Delaware, and he has worked as a welder and crane operator for

Metachem, before the buyout of Standard Chlorine 11 years ago.

When Metachem announced bankruptcy only weeks ago, he lost

a portion of his pension, as did more than 100 union and non-union

employees. The employees’ loss totaled more than $300,000. I understand that employees and management are currently negotiating and hopefully a settlement of these claims will come forward,

but Mr. Deputy joins us today to share his story.

I welcome all of you. Thank you for your willingness to share

your stories with us. Also, by the way, accompanying Mr. Deputy

is Jeff James, of Middletown, Delaware, and he also worked for

Metachem for 14 years.

Again, for the record, there is no evidence, there is no proof,

there has been no case made, there has been no decision made by

any criminal court that either of the corporations mentioned here

has engaged in criminal activity or violated the criminal law.

So let me begin now with you, Mr. Prestwood, and I welcome

your testimony.

STATEMENT OF CHARLES PRESTWOOD, CONROE, TEXAS

Mr. PRESTWOOD. Thank you, Mr. Chairman, for having the opportunity to appear before in front of your Committee.

Like you stated a while ago about the things that have really

happened in our lives, we have had a 180-degree turnaround in our

lives.

Chairman BIDEN. I hate to ask you to do this. As modern as this

place is supposed to be, we are the most antiquated institution in

the world. Can you pull that microphone—you have got to bring it

right up to your mouth because people in the back are straining

to hear what you have to say. If you could just lean into it just like

I do, if you would.

Mr. PRESTWOOD. Is that better?

Chairman BIDEN. That is it; you have got it.

Mr. PRESTWOOD. All right, sir.

Chairman BIDEN. And those Texans back there understand you.

Those folks from Massachusetts may need a translator.

Please proceed.

Mr. PRESTWOOD. Thank you, sir.

Like you stated a while ago about what kind of effect is this having on us, it is a tremendous effect. In other words, it is 180 degrees. It is a complete turnaround because when I retired from

Enron on October 1, 2000, I had plans on doing some traveling, my

fiancee and I, and we had plans of doing a lot of things, see some

of this good old beautiful USA.

But since everything happened the way it did at Enron, I do good

to stay home, and it is awful expensive even to stay home. I didn’t

have to worry if a refrigerator or water well pump or something

like that went. I didn’t have to worry about that because I had
6

some money to back it up and I could replace it. Now, it is my

prayer everyday that everything will hang in there until I can get

better financially if I sell a little piece of property that I own or

something and kind of tie over my house note and one thing and

another.

When you think about the mental end of it, that is where it really hurts you. When you go to bed at night knowing what you did

have and you go to bed now knowing what you don’t have, in other

words, it makes you real thankful for the things that you do have.

In other words, we just went back in time. There is no other way

around it. We just went back in time because our lifestyle has completely changed and the stock that we had is worthless now.

The word ‘‘loyalty’’—right now, I do have two definitions of that

word. The one that I lived by for 33 1⁄2 years kind of left me hanging out on a limb when I found out that the real true definition

of it wasn’t exactly what I was thinking.

There is one little article here I would like to read and it is in

the testimony here.

‘‘Simply stunning. That is how Chief Executive Officer Jeff

Skilling described Enron’s strong financial and operating performance in 2000. Every major business—pipelines, wholesale services,

retail and broadband—turned in strong performances for the year

that were reflected in record volumes, contract value and profitability. Revenues increased two-and-a-half times, reaching $101 billion. For the first time, Enron’s pre-tax net income exceeded $1 billion, a 32-percent increase over last year, and shareholders received an 89-percent gain on the stock price. Other significant

highlights were included,’’ which we won’t go into that, but it will

be down there.

Enron Business met with Jeff to discuss last year’s results and

his outlook for 2001. Enron Business asked the question: Enron

had a great 2000. How did we do it? Jeff Skilling’s answered,

‘‘Every one of our businesses performed beyond our expectations.’’

Well, you know, the way I look at that, is if there was any truth

in that, Enron would still be going strong. There was something

wrong somewhere along the line; in other words, the inflated price

or the process or the type or the manner of bookkeeping or whatever might have been the problem.

But, you know, every time you talk to someone and you hear

someone else talk like on Committee and all, this must just be one

big dream, you know, because nobody did anything wrong. If somebody didn’t do anything wrong, why is Enron right now not worth

$100 a share? And it would probably go for, what, 10 cents, 15

cents a share?

That is my plea. As hard as we worked, in other words, it was

one of the greatest achievements in my life when I retired knowing

that I helped build the seventh largest corporation in the United

States. I was very proud of my company, you know, and really I

am still proud of Enron. Ninety-nine and one-half percent of the

people that worked for Enron are good people. They are hard-working, tax-paying, vote-toting people, just regular, common folks.

It is a shame that the little minority at the top of our list or

whatever it might be has destroyed such a great corporation. To

me, that is a shame. I thought we had some protection on different
7

agencies. Even at the Federal level, I thought that we had some

protection against things like that.

But I find out that I was wrong on it because the problems that

occurred with the bookkeeping or whatever the problem might have

been with Enron should have been taken care of in 1997, not 2001,

because if it would have been taken care of in 1997, I firmly believe

that Enron would still be going strong today.

But, you know, there are so many ways that people can look at

it, but really and truly for us—and I feel like I am speaking for

all of the retirees, all of the ex-employees and the employees that

work for Enron now that lost everything they had and lost their

401(k)s and their ESOPs, and also the ones that got laid off and

didn’t get the right severance pay and one thing and another like

that. In other words, this is not the American way. To put it real

blunt and plain, this is not the American way for things like that

to happen and for people to let things like this happen.

So I would like just to take a look at what down the road looks

like for me. Down the road looks real grim, real slim, you know,

but I hope and pray that things get better. I hope and pray that

my health holds up. If my health would hold up and I was a young

person, I promise you it wouldn’t be any problem. I would be out

working somewhere. But I can’t. I have a heart condition and stuff,

you know, so I am kind of at the mercy of the world, so to speak.

I really appreciate you all listening to me and I am honored to

be here.

Chairman BIDEN. Mr. Prestwood, what do they call you, Charles,

Chuck, Charlie?

Mr. PRESTWOOD. Charlie.

Chairman BIDEN. Charlie, when you were a young man, did you

ever think the day would come that you would know what a 401(k)

was or any of that kind of stuff?

Mr. PRESTWOOD. No, sir, I sure didn’t.

Chairman BIDEN. Did you feel pretty good about knowing that

stuff when you got to know it?

Mr. PRESTWOOD. Yes, sir, I did, and for several years, my latter

years with Enron, I didn’t save any money. But I was always

raised to save what you got, don’t spend it, don’t draw your money

out and buy that new car and get one like your neighbor has or

something. Keep it there, let it grow, you know. What little bit you

can save, put it in there and forget it.

Chairman BIDEN. Charlie, when you were a kid, what made you

more angry, the guy who—what would upset you more, the guy

who came up to you and you knew wasn’t your friend and tried to

take you on or the guy who you thought was your friend and you

found out when the fight started he was on the other side? Who

are you more angry with?

Mr. PRESTWOOD. The second guy.

Chairman BIDEN. That is right.

Mr. PRESTWOOD. The one that I thought was my friend.

Chairman BIDEN. Because he took advantage of you, didn’t he?

Mr. PRESTWOOD. Yes, sir.

Chairman BIDEN. I think there are a thousand old expressions

that I think every legislator should understand here because they

know it in their heart, too. I am going to make an analogy for you,
8

something I spent a lot of my life working on, and that is how

women are victimized by violence.

I had a whole bunch of psychiatrists come and testify over the

years here, because men say sometimes, well, why, if a woman is

raped, doesn’t she report it, or why can’t she recover from it or

whatever. All these experts came, whether they were liberal, conservative, whatever they were, and they said one thing. They said,

you know, a woman who is taken advantage of walking down the

street and somebody jumps out of a blind alley and drags her in

and abuses her, she is scarred and that is real bad, but she can

recover psychologically, mentally, with a little help.

But the woman who gets in a car with somebody she has known

for 20 years, with somebody she works with, with the husband of

her friend or a guy that she voluntarily agreed to go out on a date

with, and he does something really bad to her, it takes her a lot

longer to recover because she ends up blaming herself. She says

‘‘why didn’t I know?’’ At least this is what all the psychiatrists tell

me, all the experts tell me.

Charlie, I grew up with guys like you, which I am proud of, guys

who busted their neck and thought just kind of fair play, just fair

play. If you wanted to get the guys in Claymont, Delaware, which

is a little steel town—if you wanted to get them up, you just take

advantage of them, suck them in, get them to trust you and then

violate that trust. Well, baby, then you had a problem because that

is the ultimate sin where you and I come from, the ultimate sin,

is to lie to me, pretend you are my friend, lie to me and take advantage of me.

Mr. PRESTWOOD. Right.

Chairman BIDEN. What happens is when it is all over, I blame

myself. Why didn’t I know better? Why did I do this? You lay in

bed now wondering why you didn’t take that money out of that account now, right? I mean, now you wish you had taken that money

out five years ago, whether you bought that car or not or done

something with it, bought some land, right?

Mr. PRESTWOOD. Well, yes, sir, but I don’t know. I am from the

old school and I still trust people. The reason I didn’t take mine

out is honesty. The reason I didn’t is I trusted Enron.

Chairman BIDEN. That is right.

Mr. PRESTWOOD. I had full confidence in them, and then I also

trusted the Wall Street people. In other words, I looked at that little computer everyday and when that Enron shop was 100 feet underwater, the analysts were still hollering, screaming, ‘‘strong buy,’’

you know, and it is 100 feet underwater. You know, that tells me

something now.

Chairman BIDEN. That is where they belong, 100 feet underwater.

I just think it is important that we understand this. This is not

a minor thing. Have you ever been robbed? I don’t think anybody

your size, anybody would try to fool with you when you were

younger, but have you ever been robbed or your car stolen or your

house broken into?

Mr. PRESTWOOD. No, sir. I have been fortunate, very fortunate.

Thank God for that.
9

Chairman BIDEN. Well, when that happens to you, unless you

are wandering someplace you think you shouldn’t have been, you

usually go home mad. You don’t go home wondering ‘‘why did I let

that happen’’ usually. Or if you come home and your house is burglarized, it is like you are mad.

But when you say, hey, man, I will give you a ride, I will help

you out, and then he takes your car, that is a real problem, right?

Mr. PRESTWOOD. Yes, sir.

Chairman BIDEN. I will come back to you if I can, Charlie.

[The prepared statement of Mr. Prestwood appears as a submission for the record.]

Chairman BIDEN. Ms. Farmer, I would like to hear what you

have to say, if I could. Thank you for, as Strom Thurmond says,

pulling that machine up close.

STATEMENT OF JANICE FARMER, ORLANDO, FLORIDA,

ACCOMPANIED BY JEFFREY FARMER

Ms. FARMER. I learn fast.

Chairman BIDEN. I can tell.

Ms. FARMER. I do appreciate the opportunity to be here before

this Committee, and I am a very proud woman and it is with extreme emotional difficulty that I come here today to share my financial plight and my personal problems. But I feel compelled to

explain my situation to you, and in doing so I truly hope to be the

voice of all Enron employees.

I once had $700,000 in my 401(k) savings plan, and that was in

late 2000. After years of hard work and dedication, I had achieved

my life’s dream, enough money to retire comfortably and live independently and financially secure. It was part of my dream to leave

my children and grandchildren a respectable inheritance to enrich

their lives.

For all of those years, I faithfully put money into my savings

plan and I fiercely protected it, never touching my savings no matter what hardship came along. In 1994, Enron had discontinued

their formal retirement program and they made each employee responsible for their own retirement planning. I still tenaciously

hung on to my dream and worked toward it.

Then, in 2001, at the most critical time, Enron denied employees

access to our own money. The shrewdly scheduled lock-down of the

401(k) denied other employees and myself access to our money for

weeks, and this was just prior to the collapse of the seventh largest

corporation in the United States.

While company executives managed to sell stock worth millions,

we employees were brutally forced to watch helplessly while the

401(k) lost $1.3 billion in value. As I understand it, the plan administrators had the opportunity to either lift or even postpone this

lock-down and they chose not to.

I feel it is very clear that employees were not only victimized by

Enron executives, we were sacrificed for their own personal gain,

and what had taken me a lifetime to build was destroyed in only

a matter of days. When the lock-down finally lifted and I was allowed access to sell my stock, I received a check for $20,418, and

that is all that was left.
10

I am now 61 years old. I won’t have the opportunity to recoup

my losses. I suffer from degenerative arthritis of the spine, along

with three ruptured discs. I am diabetic, and that has caused neuropathy of the lower extremities. I also have Plantar’s fascitis,

which is like having constant muscle cramps on the soles of both

feet, and it is really painful and it is disabling.

I try to get by now on Social Security survivor’s benefits, which is only about $500 a month, and that is after health insurance and

medical prescription costs. But out of that $500, I also have to pay

my car and house insurance and my property taxes. Whatever will

I do if I ever get sick or if anything breaks down? I don’t know.

I am afraid of my electric bill now. At night, I sit home in the

dark. I use no heat during the winter time and I don’t allow myself

to use air conditioning. The lowest I have been able to get my bill

down to is $51. There are a lot of other ways I save now. I stopped

the newspaper delivery, and I was really glad when I got a $33 refund on that because that is now a week’s worth of groceries.

I stopped by yard service and I try to do it myself on good days.

I cut my telephone and other household services to the very minimum, and I don’t shop at Publix anymore or nice department

stores. I shop at discount food stores and thrift shops.

I don’t mean to give the impression that I am too good for this

or above any of it, but this is not what retirement was supposed

to be like and it is certainly not what Enron had touted to its employees all those years. We were lied to about the financial condition of our company and the future of our company. They told us

everything was great, never better, but those lies were all part of

the sham and Enron had become a house of cards, and the people

that knew it protected only themselves.

They took more than my money and my dream. They destroyed

my pride in my whole career. I am totally ashamed that I worked

for Enron. The emotional toll on myself and my family defies description. The strength and the support from my children and my

close friends has been invaluable.

The executives, even this long after their criminal behavior, go

scot-free. They are living their normal lives of luxury. They in no

way have negatively been affected by their illegal actions, and the

amount of money they took from me surely was 1 percent or less

of what they already had and they took my money anyway.

To me, what a blatant and enormous testimony to corporate

greed. When does it stop? If this is the way corporate America repays dedication and loyalty, how many millions do they need to feel

secure? We employees, average Americans, trusted in the system.

We played by the rules, and we were lied to and cheated not only

by Enron but also the auditors and the Wall Street analysts.

We have done nothing wrong, but yet we suffer the greatest pain

and we suffer the greatest losses. If the collapse of Enron does not

show that employees’ needs and lives are being swept under the

carpet as mere inconveniences, what will it take?

It is my deepest hope and prayer that this Judiciary Committee

can give us assistance in getting back what is rightfully ours. Give

us retribution, make us whole again, give us protection, put into

place measures that will help prevent such rampant white collar

crime, make the punishment more appropriately severe and swift.
11

I truly appreciate the opportunity to participate in this victim

impact panel and to make my plea to you for justice. Thank you.

Chairman BIDEN. Thank you, Ms. Farmer, for a very moving

statement.

Did you have a statement to make? You are welcome to if you

would like.

Mr. FARMER. Sir, I did not prepare anything for the Committee.

I am solely here for moral support, although I would like to add

that this morning while we three were sitting at breakfast, and listening to Mr. Prestwood, I had a one-way view of the situation that

retirees were in from Enron, namely from my mother’s situation.

But listening to Mr. Prestwood and as we talked, I realized how

many thousands more people it had affected just from the Enron

employees, their families, the children of their families, everybody

down the row.

I understand that it is my responsibility as a son to take care

of my mother. The burden falls on my shoulders and my sister’s

shoulders as she gets on in years and needs our help. It would have

been a whole lot easier if Enron had taken care of their employees

like they should have.

I think at this point, although I am willing to accept the complete responsibility of that, I think Enron or anyone in this situation, any company that would do this to their employees, should

help with the responsibility.

Chairman BIDEN. There is an old expression: you can lock your

front door to keep the burglar out, but you can’t lock your heart

to keep the liar out.

Ms. Farmer, your son and your daughter are prepared to take

care of you. Does that bother you?

Ms. FARMER. Yes, sir, it does.

Chairman BIDEN. Why does it bother you?

Ms. FARMER. Because I have always been independent. I have

been a single woman since the mid–1970s and I have always taken

care of myself and it has always been of utmost importance that

I maintain that capability to be their support. Now, like Charles

said, it has turned 180 degrees. I am now dependent on them. They

come down for Christmas dinner and they bring food. It is not supposed to be like that. Everything I have worked for all my life is

gone.

Chairman BIDEN. I think that is an important point to make

here. My dad has been a hard-working guy his whole life. He is 87

years old and never worked for a company where they had a pension plan, and the one that did lost it before we had protection for

pension plans. I am not alleging fraud or anything. The company

just went under.

My dad and mom have their house, and a long time ago I authored a bill called the reverse mortgage which allows an elderly

person to be able to get a mortgage and get ‘‘x’’ number of dollars

a month to help them sustain themselves, to live in their house as

long as they are alive, and when they pass away the house is sold

and whatever money that was gotten to help them live is taken out

of the proceeds of the house.

My mom and dad have four kids. My brothers and my sister, like

me, have been very successful. So my mom and dad are in a posi-
12

tion where they have sort of reinsurance from their children. My

dad is in pretty tough shape now physically and they are living

with me, but they still have their home because we are going

through this fiction that they are going to move back into their

home.

My mom came to me very upset that ‘‘this reverse mortgage,

honey, is using too much of the value of my house.’’ And I said,

‘‘Mom, it is okay, so what?’’ She said, ‘‘I will have nothing to leave

you, I will have nothing to leave you.’’ My mother is 85 years old

and my mother doesn’t want to take $500 a month out of her house

to supplement her Social Security because she is not going to have

anything to leave me. I hope when we think about penalties, we

think about consequences to people.

Now, my mom’s situation is different. It is the same impact, the

pride piece, but I am not suggesting any wrongdoing relative to

anything that happened to my mother or father. But I think sometimes we forget you raised us to be proud.

Ms. FARMER. That is right.

Chairman BIDEN. You raised us to be independent. I am not very

far behind you, by the way, in age, so it is not like we are different

generation here.

[The prepared statement of Ms. Farmer appears as a submission

for the record.]

Chairman BIDEN. Mr. Deputy, tell me about the deal down at

Metachem. How did you lose some of your retirement? How did

that happen? You are a pretty young guy. How old are you?

STATEMENT OF HOWARD DEPUTY, SMYRNA, DELAWARE

Mr. DEPUTY. I am 35.

Chairman BIDEN. Thirty-five years old?

Mr. DEPUTY. Yes, sir.

Chairman BIDEN. My staff tells me you lost a chunk of your retirement.

Mr. DEPUTY. Yes.

Chairman BIDEN. How did that happen?

Mr. DEPUTY. They filed for taxes, like a tax extension, and they

said by law they could and then they closed the plant.

Chairman BIDEN. What were they supposed to do?

By the way, I understand you just got off work at six o’clock and

you hopped on a train?

Mr. DEPUTY. Yes, sir.

Chairman BIDEN. I hopped on the early train, too, but I didn’t

work until six o’clock this morning. So obviously you feel pretty

strongly if you are down here and you worked all night and you

are on the train at seven o’clock in the morning to get down here.

Let me make sure I understand. How does your retirement system work at Metachem?

Mr. DEPUTY. Once a year, they would make their deposit when

they did your tax.

Chairman BIDEN. So when they did their taxes, what they would

do is the money you kicked in and the money that they had promised they were going to put into this pension fund—right?

Mr. DEPUTY. Yes, sir.
13

Chairman BIDEN. They would put it in at the time that they paid

their taxes, right?

Mr. DEPUTY. Yes, sir.

Chairman BIDEN. Now, am I correct that Metachem made a yearly payment, supposedly, of 6 percent of your annual salary into an

investment plan of your choosing?

Mr. DEPUTY. Yes.

Chairman BIDEN. So if your salary was $1,000, they paid 6 per- cent into a fund and they paid $60 into a fund?

Mr. DEPUTY. Yes, sir.

Chairman BIDEN. This year, how much were they supposed to

pay for you, do you know, into this fund when they paid their

taxes?

Mr. DEPUTY. It is roughly like $3,000.

Chairman BIDEN. Three thousand bucks, and that was for you

and all the other employees, right?

Mr. DEPUTY. Yes, sir.

Chairman BIDEN. What did they tell you? Did they put the

money in?

Mr. DEPUTY. For the first four months of this year.

Chairman BIDEN. So for 16 months, they didn’t put any money

in, is that right? For 16 months they didn’t put any money in?

Mr. DEPUTY. No, sir.

Chairman BIDEN. Did you know they weren’t putting the money

into the fund?

Mr. DEPUTY. They gave us a letter right at tax time and that is

when they told us.

Chairman BIDEN. And what did they tell you?

Mr. DEPUTY. It was legal, you know. That is about it.

Chairman BIDEN. And so if I have it straight now, you were supposed to have $3,000 deposited in your retirement account, the investment plan that you had chosen, right?

Mr. DEPUTY. Yes.

Chairman BIDEN. And it was supposed to take place when they

paid the taxes. Tax time comes and they didn’t put it in, right?

Mr. DEPUTY. They filed for an extension.

Chairman BIDEN. They filed for an extension?

Mr. DEPUTY. Right.

Chairman BIDEN. And then what did they do?

Mr. DEPUTY. Then they filed for bankruptcy.

Chairman BIDEN. So, obviously, you are kind of in the back of

the line, then, now, right?

Mr. DEPUTY. Yes, sir. They took everybody’s vacation, too, that

you had earned from the previous year.

Chairman BIDEN. Now, it is my understanding that this once-ayear payment was made around the 15th of April of each year for

the prior calendar year. For example, in 2001 Metachem made its

employee contribution for calendar year 2000, and that is how it

worked until this year.

This year, Metachem didn’t make an annual pension payment for

calendar 2001. I understand that the 2001 payment for union employees was about $140,000 they were supposed to pay in for union

employees, right?

Mr. DEPUTY. Yes, sir.
14

Chairman BIDEN. For both union and non-union employees, it was about $300,000 they were supposed to pay in, right?

Mr. DEPUTY. Yes, sir.

Chairman BIDEN. And they didn’t pay any of that in?

Mr. DEPUTY. No, sir.

Chairman BIDEN. I understand that the specific 2001 pension

payment which Metachem was supposed to make into your account

was, they tell me, $2,688. Is that right?

Mr. DEPUTY. Yes, sir.

Chairman BIDEN. Now, I am not aware of any evidence of fraud

on Metachem’s part, but I want to be clear about that. Is it correct,

Mr. Deputy, that you and the other employees thought—what did

you think about the timing of this? Let me ask you that way.

Mr. DEPUTY. It was fishy.

Chairman BIDEN. It was fishy. Specifically, the company told you

that it could not make its annual payment because it needed a tax

extension, right?

Mr. DEPUTY. Yes, sir.

Chairman BIDEN. They didn’t tell you they didn’t make it because they were fixing to declare bankruptcy, did they?

Mr. DEPUTY. No, sir.

Chairman BIDEN. Did you and the other employees believe, at

least at the time, that Metachem refused to make the annual payment because they knew they were going bankrupt?

Mr. DEPUTY. No, sir, because we thought we were owned by

Charter Oaks.

Chairman BIDEN. Now, I don’t have, again, any evidence of

wrongdoing on the part of Metachem in terms of criminal wrongdoing, but I want to ask you a question about penalties for other

companies who defraud pensions. I want to ask all of you this.

Pensions are regulated by a Federal statute known as ERISA,

the Employee Retirement Income Security Act. If a criminal violation occurs under ERISA, however, the most the pension crook can

get is one year in jail. That is the most they can get, one year in

jail, regardless of how much money is lost by the company’s employees. Incredibly, it is possible that this white collar crime crook

could even get probation if your life savings are gone forever. Now,

that is under ERISA.

Were you aware of that, that you could only get one year in jail?

Mr. PRESTWOOD. No, sir.

Ms. FARMER. No, sir.

Chairman BIDEN. And that the defendant could actually get probation if they were convicted?

Ms. FARMER. No.

Chairman BIDEN. Let me ask you this: What do you think is fair?

I mean, let’s assume it was proven in a court of criminal law that

you were defrauded. What kind of penalty do you think the people

responsible for defrauding you should get?

Charlie, what do you think?

Mr. PRESTWOOD. Mr. Chairman, would you let me answer that

in my point of view?

Chairman BIDEN. I sure would.

Mr. PRESTWOOD. Lifetime, with no parole. There wouldn’t be too

many people defrauding people then, you know. You set two or
15

three examples and the rest of them will take note of it, is my way

of thinking.

Chairman BIDEN. What do you think, Ms. Farmer, for real? I

mean, how do you think it should be dealt with? I know your instinct and your heart would say hang them from the nearest tree

kind of thing, I guess, but if one year is not enough, how do you—

let me give you an example.

If you steal a car, under Federal law, and you take it across the

State line, you get 10 years in jail. Auto theft is a serious crime

and it should be dealt with severely. So if, under ERISA, someone

was convicted for violating that law, they get one year in jail. If

they steal your car and take it into Georgia, they are going to get

up to 10 years.

Ms. FARMER. To me, that makes no sense. I mean, there is no

equilibrium there; it doesn’t balance. I tell you one thing, if they

get more than one year in the penitentiary, that would be fine, but

I just want what is mine. I want it back. They don’t deserve to

have it.

Chairman BIDEN. Mr. Deputy?

Mr. DEPUTY. I think it should be the same penalty as like with

a gun, you know, a stiff penalty.

Chairman BIDEN. There is not a lot of distinction to you if some- one comes in and sticks a gun in your face and takes $3,000 of your

money?

Mr. DEPUTY. Yes. You can’t do anything about it, and the same

way when they sneak it out, you can’t do anything about it.

Chairman BIDEN. Well, that is one of the things we have to look

at here. I am not trying to hype this, but I think it is important

to just look at the equities here.

Ms. FARMER. I agree.

Chairman BIDEN. If I take your car and I take it into New Jersey, and I take your car into Georgia, and take yours into Oklahoma—I don’t know why I would do that, but only a Texan would

appreciate that.

Ms. FARMER. Especially if you saw my car.

Chairman BIDEN. And no matter what your car is like, by the

way. Your car can be a 20-year-old jalopy or a brand new Mercedes

and there is no difference in terms of if they cross that State line.

It is 10 years.

Well, I want to thank you for taking the time to be here. I know

it is not easy, but it is important that we put a human face on

what we are talking about here. We are not just talking about dollars. We are not just talking about, in the abstract, people’s futures

are changed. We are talking about not only your money gone, but

your pride is gone and your sense of what you think your responsibility is to your children is gone.

Ms. FARMER. Yes, sir.

Chairman BIDEN. Charlie—you know, here is a guy who busted

his neck, worked hard his whole life and got things those college

boys get, right? I mean, seriously, think about it, think about it.

This is a big deal. It wasn’t just the money, was it?

Mr. PRESTWOOD. No, sir.

Chairman BIDEN. It was the knowledge that you built this and

you were part of this deal. I mean, did you ever think you would
16

be on a computer looking at stock prices, for Lord’s sake, and

quotes when you were a kid?

Mr. PRESTWOOD. No, sir. The only stock I knew of was the animals we had out in the barn.

[Laughter.]

Chairman BIDEN. That is right, exactly right. By the way, you

couldn’t afford to keep those animals right now, based on what you

have, right?

Anyway, I promise you we are going to try to come up with an

equitable way in which to deal with this because this has to be fair.

I want to tell you I can think of not a whole lot, other than your

physical safety, that I think we should value more than your financial security.

The good news for Howard is he is 33 years old and he has a

whole life ahead of him. He is going to get a kick in the teeth from

this, whether there is criminal activity or not, because of the bankruptcy, but I think he is going to be wiser for it and know what

is going on.

And I don’t think it is a good thing for you, by the way. Every

time something lousy happened in my life, people would say it

builds character. And I would say I have got enough character, I

don’t need any more character. I am not suggesting you need any

either, but in the case of our other two witnesses, although they

are not that old, for physical reasons and others, their options are

limited.

Charlie and Janice, to be blunt with you, I am not sure there is

anything we are going to be able to do to get you back your money.

That is another question, but I do think that we have to consider

what you both said that if there were adequate penalties, maybe

these guys would have thought twice about what they did or didn’t

do when they were making these judgments, if, in fact, penalties

are deterrents, and I think in this case they may very well be.

So I thank you all. If you have any closing comment any one of

you would like to make, I am happy to have it. I know you probably got up early and you probably want to get going, but I say to

both of you my staff is available. Why don’t you all come around,

and because you came a long way, unless you already have plans,

we will arrange for you to eat in the Senate dining room or get you

something to eat here. I mean, this has been a real sacrifice to

come up just for an hour or so, so we will take care of that. I am

not saying the Senate will. I will. I want to make it clear I am not

spending the taxpayers’ money here. This is not the taxpayers’

money, okay?

Ms. FARMER. Thank you.

Chairman BIDEN. So we will just make arrangements if you all

need any because I know it was an inconvenience.

Howard, I will see you at home, but if you need anything while

you are here, too, I invite you to come into this room and my staff

will be there if you need any assistance or would like any, or would

like us to arrange to make sure you get some lunch here, if that

is okay.

Ms. FARMER. Thank you. That is a generous offer.

Chairman BIDEN. Well, thank you very much for being here.

Yes, Charlie?
17

Mr. PRESTWOOD. Mr. Chairman, you know, looking at that little

chart up there, you take that car that would cost about $30,000

and the criminal offenses over here could reach up to maybe $2.2

billion. There is a difference there. Something is wrong with the

law or something, it looks to me like.

Chairman BIDEN. Well, I think you are right, Charlie, and we

are going to try to fix that.

Ms. FARMER. I agree.

Mr. PRESTWOOD. I thank you, sir. It is an honor to be here.

Chairman BIDEN. Thank you. It is an honor to have you here.

While our first panel is clearing out, I want to again thank them

for being here.

Our second panel is James B. Comey, who was recently appointed the United States Attorney for the Southern District of

New York. He attended the College of William and Mary and the

University of Chicago Law School, and later clerked for Federal

District Judge John M. Walker, Jr., in Manhattan.

As Assistant U.S. Attorney in the office he now heads, he prosecuted members of the Gambino crime family. Before being appointed to his current position, he served as Assistant U.S. Attorney in Richmond, Virginia, where he earned praise as a prosecutor.

As head of an office that handles an enormous amount of white collar crime work, we look forward to his testimony today.

Glen B. Gainer, III, serves as the West Virginia State Auditor

and Chairman of the National White Collar Crime Center. He is

a trustee for the National Coalition for the Prevention of Economic

Crime, and chairs the Audit Committee of the West Virginia Investment Management Board. He is on the Executive Committee of

the National Association of State Comptrollers and is Vice President of the West Virginia Consolidated Public Retirement Board.

Mr. Gainer, welcome to Washington.

Mr. BRADLEY W. Skolnik is the Securities Commissioner for the

State of Indiana and Chairman of the Enforcement Division of the

North American Securities Administrators Association, an organization over which he presided from September of 1999 to September of 2000.

Mr. Skolnik earned his bachelor’s degree at Michigan State University in East Lansing and his law degree at the Indiana University School of Law in Bloomington. He began his legal career as a

law clerk in the office of a prosecuting attorney in Michigan and

went on to clerk for the Indiana Court of Appeals. We look forward

to his testimony, as well.

Frank O. Bowman, III, is an Associate Professor of Law at Indiana University School of Law in Indianapolis, where he teaches

evidence, criminal law, and criminal procedure. Following his graduation from Harvard Law School in 1979, Professor Bowman entered the U.S. Department of Justice as part of the Honors Graduate Program. He spent three years as a trial attorney in the

Criminal Division in Washington.

From 1983 to 1986, he was deputy district attorney in Denver,

Colorado, and he also spent three years in private practice in Colorado. In 1989, Professor Bowman joined the U.S. Attorney’s Office

in the Southern District of Florida, where he was deputy chief of
18

the Southern District Criminal Division, specializing in complex

white collar crime.

In 1995 and 1996, he served as special counsel to the United

States Sentencing Commission, in Washington, D.C., and in 1998

to 2001 he served as academic adviser to the Criminal Law Committee of the United States Judicial Conference.

Welcome, Professor.

Paul Rosenzweig is a Senior Legal Research Fellow at the Heritage Foundation’s Center for Legal and Judicial Studies. He attended Haverford College, in Pennsylvania, a great school, and the

University of Chicago Law School, after he which he clerked for the

Eleventh Circuit Court of Appeals. He worked for seven years as

part of the Justice Department’s Environmental Crimes Section,

and then for a time as the Chief Investigative Counsel for the

House Committee on Transportation and Infrastructure. Most recently, he was senior litigation counsel and associate independent

counsel under Ken Starr. We look forward to his presentation

today, as well.

I thank you all for being here. If we could, if you would begin

and try to keep your statements relatively short, your entire statements will be placed in the record.

If we begin in the order that I introduced you, Mr. Comey.

STATEMENT OF HON. JAMES B. COMEY, JR., UNITED STATES

ATTORNEY, SOUTHERN DISTRICT OF NEW YORK, NEW YORK,

NEW YORK

Mr. COMEY. Thank you, Mr. Chairman. Thank you for inviting

me here today. I welcome the opportunity to appear before this

Subcommittee on behalf of the Department of Justice to discuss

these important issues and the penalties for white collar crime.

As you have said, Mr. Chairman, the swift and certain punishment of financial crimes is essential to protecting this country’s

economy. The prosperity of our great country and all the good that

flows from it are made possible by the Federal, State and local laws

that bring a degree of order and predictability to commerce and

that protect citizens from the predation of criminals who use a pen

or a computer and not just a knife or a gun.

But as you also know, the real and immediate prospect of significant periods of incarceration is necessary to give force to those

laws. Nothing erodes the deterrent power of our laws and breeds

contempt, frankly, for obeying the law more quickly than if certain

criminals appear to receive punishment not according to the gravity of their offense but according to their social or economic status.

The Department of Justice is committed to the vigorous enforcement of laws against all forms of financial crime, and our position

on this issue is straightforward and we hope inarguable.

White collar criminals have broken serious laws. They have done

grave harm to real people like the real folks who were seated at

this table before we sat down, and they should be subject to the

same type of retribution that we accord all serious crimes—a significant chunk of jail time.

We have made significant progress in recent years, especially in

improving the Federal Sentencing Guidelines. We are very pleased

that the Sentencing Commission amended the Guidelines for white
19

collar offenses to raise the penalties on those who are responsible

for significant financial loss, although the penalties were decreased

to some extent for the smaller-time crooks.

Both the Department and the Commission will be closely examining the effects of those recent amendments on cases that are just

now being prosecuted and coming through our offices, and we will

pay particular attention to what happens at the lower-end cases

which make up a large proportion of the cases prosecuted by U.S.

Attorneys.

We remain concerned with amendment proposals that have been

made to the Commission in past years that could undermine the

progress that has been made so far. We are pleased that the Commission has seen fit to reject efforts to reduce punishment for the

most serious offenders.

White collar offenders are generally better educated, in the experience of U.S. Attorneys, and more sophisticated than most criminals. They commit their crimes not in a fit of passion or out of addiction or a craving, but with cold and careful calculation. They

are, in my experience, the most rational of offenders and are more

likely to weigh the risks against the anticipated rewards of committing a crime.

They can be deterred, but the penalties must be certain and significant. They have to fear going to jail. If you ask a criminal defense attorney who represents a white collar defendant, they will

tell you the thing they are most afraid of is going to jail. People

like that with a lot to lose are exquisitely sensitive to the pain of

deterrence because they don’t want to go to jail.

The certainty of these significant penalties in white collar cases

also fosters trust in our criminal justice system, which is the bedrock of the system. If drug defendants and violent offenders are

routinely sent away for long stretches, while white collar offenders

routinely get probation or home confinement or a halfway house,

people are going to start to think that felons with wealth or privilege or education or the right color are not held to the same standards as ‘‘regular criminals’’ and that people are above the law. We

believe that white collar sentences to jail can and will lead to restitution to the victims of their crimes. There is nothing inconsistent

about a jail term and restitution.

Lastly, I just want to add a word about downward departures.

Because Congress intended the Sentencing Guidelines to cover

nearly every factual circumstance in a criminal case, judges are

only rarely supposed to depart from the sentence range that the

Commission has set out.

We U.S. Attorneys are very concerned about the increasing number of non-substantial assistance departures in white collar cases,

in particular. It sometimes appears that Federal judges don’t want

to put white collar defendants in jail, and that they work to eliminate or reduce that jail time because of the defendant’s civic work

or charitable work or his great employment record or his big family

or his health problems, or a whole host of factors that the Guidelines say are discouraged, but that judges find are present to a degree outside the heartland, and therefore it justifies sending this

guy home or to community confinement. These departures can be

found by a good defense lawyer in almost every case, and we think
20

they erode the already less onerous penalties in the white collar

area.

In conclusion, we think that white collar offenses are situations

where punishment and severity are vitally important, as important

as in the cases you mentioned, the drug and violent crime cases.

We appreciate the work of the Sentencing Commission in bolstering the offense punishment for major offenders. We hope that the

Commission will continue to stand strong against proposed changes

that would undermine that progress, and we look forward to working with the Commission and this Subcommittee to ensure that

Federal sentencing is designed to reduce crime in the most efficient

possible way.

That concludes my prepared remarks, Mr. Chairman. I ask that

the full text of my remarks be incorporated into the record.

Chairman BIDEN. Without objection, they will be.

[The prepared statement of Mr. Comey appears as a submission

for the record.]

Chairman BIDEN. Mr. Gainer?

STATEMENT OF GLEN B. GAINER, III, WEST VIRGINIA STATE

AUDITOR, AND CHAIRMAN, NATIONAL WHITE COLLAR

CRIME CENTER, MORGANTOWN, WEST VIRGINIA

Mr. GAINER. Chairman Biden, I come to you wearing two hats

today, first as the State Auditor of the State of West Virginia and

its Commissioner of Securities, but also as the Chairman of the

Board of Directors of the National White Collar Crime Center.

I am going to depart from my prepared remarks, since they will

be included in the record, and just speak briefly to a few issues.

As a regulator of the securities industry and serving at the National White Collar Crime Center, I see first-hand many of the

issues and problems that we are facing dealing with this issue.

Too few resources. The National White Collar Crime Center, as

you probably are aware, is funded by the Congress through the Department of Justice and Bureau of Justice Assistance. The funding

is greater than it has ever been in the past, but it is still too few

dollars to meet the great needs that we are trying to achieve.

We have over 1,000 member agencies, representing attorneys

general, securities commissioners, State police, State and local law

enforcement, as well as prosecutors across this country. We try to

provide them support not only in financial crimes training, prosecutors training, computer crimes training, but we also try to provide

them research and analytical support.

Our research section has found through our last nationwide

study that most Americans view economic crime, or what we would

consider white collar crime, to be every bit as important and deserve equal time and prosecution as traditional street crime,

though we know from our past history that is not the case.

We can look back to the 1990s when we had the savings and loan

scandal, where the average sentence for the folks involved in that

in excess of $100,000 received 36.4 months in jail. You have already used the example of car theft. At that time, car theft received

38 months in jail, traditional burglary received 55 months in jail,

and drug offenders received over 64 months in jail. As we can see,

the sentencing is not equal.
21

Another area that we have identified, and I will say as a securities regulator I find somewhat disheartening, is the complexity of

economic crime and the investigation required to do that takes an

expertise that is difficult to find. When you do find that expertise,

having the funds and the ability to maintain that staff is difficult.

But even more disturbing is when you do put a case together and

you are successful in putting a case together, taking it to the Federal prosecutors many times falls on deaf ears. I am not criticizing

the system. I understand the system. I understand the burden and

the crimes that they are trying to deal with. Many times, white collar crime is looked at as a low priority.

From the standpoint of sentencing, why would a prosecutor want

to put in thousands of hours on a case, only to get a conviction of

perhaps parole or maybe a few months in jail? I can understand

their situation, but as a regulator I find it difficult to deal with on

a day-to-day basis.

I have to answer, as do you, to my constituencies in the State

of West Virginia. If we have Federal leadership in strengthening

the law, I believe that it will go a long way in helping to prevent

economic crime in this country. We must take a strong stand.

Not only do economic criminals in this country need to understand that they are going to be prosecuted, but there will be severe

penalties for that violation of the law. Many of them right now in

the environment that we exist in are willing to take the gamble

that if they are caught, they will not be convicted, or if they are

convicted, they will probably receive probation or a very light prison sentence. This is truly an issue that we must deal with and it

has already been talked about by the previous panel.

Thank you.

[The prepared statement of Mr. Gainer appears as a submission

for the record.]

Chairman BIDEN. Thank you.

Commissioner Skolnik?

STATEMENT OF BRADLEY W. SKOLNIK, INDIANA SECURITIES

COMMISSIONER, AND CHAIRMAN, ENFORCEMENT SECTION,

NORTH AMERICAN SECURITIES ADMINISTRATORS ASSOCIATION, INC., WASHINGTON, D.C.

Mr. SKOLNIK. Thank you very much, Mr. Chairman. I am Brad

Skolnik, Indiana’s Securities Commissioner, and Chairman of the

Enforcement Section of the North American Securities Administrators Association. I commend you for holding this hearing today and

thank you for the opportunity to appear.

Our country has undergone a historic transformation. In just the

past generation, we have become a nation of shareholders. Today,

half of all households are invested in the stock market, and State

securities regulators realize we have an increased responsibility to

make sure that Wall Street is a safe street for Main Street investors.

Given all the news of late, which sometimes make the business

pages read like a police blotter, Congress, regulators, and the industry must act to restore confidence in the integrity of our markets, and we feel we can help do that by holding those who defraud

investors accountable for their crimes.
22

The strongest deterrent to white collar crime, I believe, as we

have heard today, is criminal prosecution and prison time, but

there are significant hurdles we face. Prosecutors, juries, and the

media understand street crime like robbery, assault, and murder.

Somehow, securities fraud and other white collar crimes seem sanitized, bloodless, and technical.

Many people, including some in law enforcement, view securities

fraud as an essentially victimless crime that involves as much gullibility on the part of the victim as it does culpability on the part

of the perpetrator. But we know white collar crimes aren’t

victimless crimes. Just like street crime, securities fraud ruins

lives, destroys families, steals hopes, and kills dreams.

Oftentimes when faced with a problem, the temptation is to propose new legislation. In my opinion, to protect investors we need

to make better use of the laws already on the books. This means

bringing more criminal actions against white collar crooks.

One problem is that securities cases are complex, costly, and

time-consuming, and these are serious deterrents to law enforcement agencies with limited personnel and budgets. The prosecution

of complex white collar criminal cases take time and money, lots

of money. It is critical that prosecutors and law enforcement officials be provided with the resources necessary to investigate and

prosecute these cases.

The truth is some prosecutors shy away from them because the

subject is complicated and difficult to understand. A prosecutor’s

willingness to undertake a complicated and technical securities

case also depends on other cases competing for attention. Murders,

other forms of violent crime, and drug-related cases are sometimes

easier to argue to a jury and don’t require the amount of staffing

or special expertise often required for criminal prosecution of a

complex securities case. But from my perspective as a State securities regulator, white collar criminals who commit securities fraud

deserve time just like thieves, muggers, and murderers.

There are some ways my colleagues can help. State securities

regulators can and do provide resources to prosecutors to assist

with the investigation and prosecution of these cases. We can develop cases fully and hand them over to prosecutors, both Federal

and State, reducing the burden on them substantially.

Moreover, when criminal convictions are obtained in white collar

cases, the sentences imposed are often insufficiently severe, considering the amount of harm inflicted. Think about it. If someone

steals your car, they go to prison. If some con artist steals the

money your parents need for retirement, they get fined. That is

just not right.

I also think it is important for us to stop using euphemisms

when we talk about white collar crime. White collar criminals are

cold, calculating, and vicious. All too many are serial violators, career criminals. It is probably way past time we called a crook a

crook and put more of them in jail.

On the legislative front, State securities regulators support S.

2010, the Corporate and Criminal Fraud Accountability Act of

2000, and believe it sends a powerful message that wrongdoers in

the securities markets will be punished.
23

Unfortunately, white collar crime is not as high on our national

agenda as it needs to be. However, the problems in this area can

be successfully addressed if law enforcement officials, regulators,

Congress, and others work together on solutions. I am optimistic

that the battle against white collar crime is winnable, given the

will and the right amount of resources.

Again, I thank you for holding this hearing and would be pleased

to provide any additional information you may need.

[The prepared statement of Mr. Skolnik appears as a submission

for the record.]

Chairman BIDEN. Thank you, Commissioner.

Professor?

STATEMENT OF FRANK O. BOWMAN, III, ASSOCIATE PROFESSOR OF LAW, INDIANA UNIVERSITY SCHOOL OF LAW, INDIANAPOLIS, INDIANA

Mr. BOWMAN. Chairman Biden, thank you very much for inviting

me to be with you here today. My name is Frank Bowman and I

am a professor at the Indiana University School of Law in Indianapolis.

As you were kind enough to mention, before becoming a teacher

I practiced law for a good 17 years and served for roughly 13 years

as a prosecutor in State and Federal courts. In 1995 and 1996, I

was detailed by the Department of Justice to serve as special counsel to the U.S. Sentencing Commission, and during that detail I became involved in the Commission’s long project of rethinking and

revising the Sentencing Guidelines governing economic crimes, a

project which finally came to fruition in May of 2001, when the

Commission passed its so-called economic package of guidelines

amendments.

When I left the Government to teach in 1996, I began to write

about sentencing, and in particular about the sentencing of Federal

economic crimes. I continued to work in the political realm and in

the policy realm on economic crime sentencing reform.

During the five-year process of rewriting the Federal economic

crime sentencing guidelines, I had the honor to work closely with

all of the groups most interested in the reform: former colleagues

in the Justice Department, representatives of the defense bar, the

Criminal Law Committee of the U.S. Judicial Conference, and of

course the Sentencing Commission itself. The lessons I learned during the last five years inform much of what I have to say this

morning.

The question for today is whether we are tough enough on white

collar crime. I want to make four points.

First, the average sentence imposed on a defendant convicted of

an economic crime, defined broadly, in Federal court is certainly

significantly lower than the average sentence in any other major

crime category. Economic crime defendants, broadly defined, get

probation far more than any other sort of defendant. I have included in my written testimony a chart which reflects the precise

figures for fiscal year 2000.

However, I want to emphasize that I think this comparison of

categories is probably misleading. Most Federal prosecutions categorized as economic crimes are simple crimes that involve rel-
24

atively small sums of money. For example, in 1999 half of the defendants sentenced for theft crimes and 22 percent of those sentenced for fraud stole less than $10,000. That is not a minor

amount of money, but in the scheme of the kinds of frauds that we

have been discussing this morning, it is relatively small.

Moreover, a big chunk of the Federal economic crime caseload

consists of thefts or misappropriations of Government benefit

checks, thefts of Government property, simple embezzlements from

federally-insured banks, and similar matters.

Prosecution of these kinds of cases is certainly necessary particularly where the Government itself, and thus the taxpayer, become

the victim. But there is, I think, little evidence that crimes of this

sort are under-punished. Therefore, I think that sentencing averages for all Federal economic crimes don’t tell us very much about

the appropriateness of the punishments imposed on the kind of

folks that you, Senator, were presumably thinking about when you

scheduled this hearing—people I will call serious white collar offenders, people who stole a whole lot of money in a reasonably complicated way.

The second point I want to make is a historical one, and that is

across the board for both routine, small-fry types of thieves and for

serious white collar offenders, Federal economic crime penalties are

now markedly higher than they used to be.

Prior to the enactment of the Federal Sentencing Guidelines in

1987, probationary sentences were the norm in Federal economic

crime cases, often in serious white collar cases involving significant

financial losses. The original Sentencing Commission consciously

sought to change this. They wrote guidelines that effectively mandated prison sentences, absent departures at least, for all defendants who stole more than roughly $120,000 or so.

In addition, by tying increases in sentence length to increased

amounts of loss, and by adding sentencing enhancements for factors like abuse of trust, the guidelines began routinely generating

multi-year prison sentences for white collar defendants who, before

the guidelines, would have escaped with probation or a term of

mere months.

Chairman BIDEN. I might add that was one of the reasons why

I wrote the legislation. Everybody thinks it was only the violent

criminals, but we had a lot of hearings and that was one of the big

issues back then.

Mr. BOWMAN. Senator, although many people are not great fans

of the guidelines, I for one am, and I want to thank you for your

good work in helping——

Chairman BIDEN. Well, thank you. I didn’t intervene for that, but

thank you.

Mr. BOWMAN. I want to go on to say that even though the guidelines raised the historical level of white collar offenses, in the years

after the guidelines were adopted many judges, probation officers,

and prosecutors felt that sentences for serious white collar offenders were still not high enough.

As a result, one element of the Sentencing Commission’s 2001

economic crime package was an increase in sentences in cases with

larger loss amounts. So the effect of the guidelines on white collar

criminals has been to put more of them in prison for longer, and
25

the effect of the new 2001 economic crime amendments to the

guidelines will be, I think, to increase white collar sentences still

more, at least for high-loss cases.

Therefore, another way of framing the question being asked here

this morning might be: we have gotten tougher on white collar

crime, yes, but have we gone far enough? Now, of course, there is

no objective or empirical way of deciding how much punishment is

enough.

For example, in my own view, comparisons to other dissimilar

types of crime may not be very helpful. People often remark on the

substantial difference between economic crime sentences and drug

sentences, but one has to ask whether the lesson to be drawn from

this comparison is that economic crime sentences are too low or

maybe that drug sentences are too high, or maybe the differential

is just right because they are not comparable types of crimes.

I think about the best we can do is to make some necessarily imprecise judgments about whether prevailing punishment levels are

likely to act as effective deterrents to crime, while at the same time

being neither undeservedly lenient or undeservedly harsh.

In my written testimony, I have provided some examples of the

sentences that both the old and new guidelines would produce for

some hypothetical white collar criminals who steal sums in the

range of, say, $750,000 to $1 million or $2 million.

Depending on the particular circumstances in such cases, other

than loss amount, such defendants now would be sentenced to prison anywhere from 2 1⁄2 to roughly 17 years. Lower loss figures

would produce slightly lower sentences. Higher losses would

produce higher ones.

As just an interesting aside perhaps, I did a quick calculation

during the testimony of the previous panel. Assuming that facts

were to arise giving rise to criminal liability for people involved in

the Enron scandal, which produced losses presumably much in excess of $100 million, and if such persons were to be brought to trial

and convicted, they would now receive sentences in excess of 20

years.

My third point, therefore, is this: Sentences at this level may be

a bit too low in some cases and a bit too high in others, but I find

it fairly hard to assert categorically that sentences in this general

range are obviously unreasonable. Indeed, I suspect that in most

cases, most people would probably conclude that the sentences now

prescribed by the economic crime guidelines closely approximate

rough justice.

At a minimum, I think that current economic crime sentences

are not so obviously low that Congress should command the Sentencing Commission to enact a blanket increase applicable to all

economic crimes, or maybe even to all economic crimes above a certain loss amount.

I would like to suggest further that Congress should be especially

cautious about pressing for any across-the-board white collar sentencing increases less than a year after the Commission, in conjunction with all of the interested parties, including the Justice Department, passed its economic crime amendments. The sentence increases in that package have really basically not even come into ef-
26

fect yet and it will be some years before we can determine what

is really happening there.

There may be specific types of economic crime or specific aggravating factors that the Commission has not properly accounted for

and which deserve additional sentencing enhancements. In my

written testimony, I note several such factors mentioned in Senator

Leahy’s bill, S. 2010, and I am particularly interested in the proposed enhancement which I think may be particularly appropriate,

given the testimony we have heard today, for causing victim insolvency.

Fourth, and finally, the last point I would like to leave you with

is that toughness on crime, and economic crime in particular,

should not be measured solely by the length of the sentences we

impose on the white collar defendants whom we catch and convict,

but by the resources we devote to ensuring that all those who commit serious white collar crime are caught and are punished.

For reasons that have to some extent been laid out here today

and which I explore more in my written statement, in the United

States the Federal Government is the primary, and in some jurisdictions virtually the sole investigative and prosecutive authority

for complex economic crime.

I would submit that the most valuable thing that this Subcommittee and this Congress could do to fight white collar crime

in America would be to appropriate and dedicate additional funds

for the Justice Department and the regulatory and investigative

agencies who fight white collar crime.

[The prepared statement of Mr. Bowman appears as a submission for the record.]

Chairman BIDEN. Thank you for a very thoughtful statement. I

appreciate it.

Mr. Rosenzweig?

STATEMENT OF PAUL ROSENZWEIG, SENIOR LEGAL RESEARCH FELLOW, CENTER FOR LEGAL AND JUDICIAL STUDIES, THE HERITAGE FOUNDATION, WASHINGTON, D.C.

Mr. ROSENZWEIG. Thank you, Mr. Chairman. As you have said,

my name is Paul Rosenzweig and I work at the Heritage Foundation. I am also an adjunct professor at George Mason University,

where I teach white collar and corporate crime, so this is a subject

near and dear to my heart.

I also find myself quite comfortable as last on this panel because

that position will allow me to be brief. I find myself in agreement

with much of what has been said already. I concur wholeheartedly

that some of the problem is the lack of devotion of resources appropriately to the prosecution of white collar crime.

I agree, as well, that part of the problem is the intricacy and difficulty of proving those crimes, and that is perhaps something inherent in the nature of white collar crime that no act of Congress

or the Sentencing Guidelines and no devotion of greater resources

can or ever will solve.

When and if there is ever a trial of a fraud of the size alleged

potentially against Enron, that trial will occupy a court and a

dozen prosecutors for nigh on six months, and still may be impen-
27

etrable to either the judge or the poor jury obliged to sift its way

through the intricacies of the finances there.

I also agree with Professor Bowman that for the most part the

Sentencing Guidelines have moved substantially in the direction of

making more equivalent white collar and street-type crimes.

The two points that I would add that are perhaps different than

those that have already been brought forth are these: First, to

some degree I think we need to absolve the courts of responsibility

for such disparities as remain. Much of the cause of that lies not

with them, but either here in Congress or in the guidelines themselves.

In my written statement, I have provided you with some information about the rates of imprisonment that are given to defendants in situations where judges have discretion to choose either imprisonment or some non-imprisonment type of punishment—home

detention, community service, probation, that sort of thing.

If we look at that data, we see that in those situations where discretion remains in the district court judges doing sentencing, for

the most part the rates at which they impose imprisonment don’t

vary that much based upon the nature——

Chairman BIDEN. Is that your chart on page 6?

Mr. ROSENZWEIG. That would be the one on page 4 that I am

looking at, the rates of imprisonment.

We do see that drug traffickers get——

Chairman BIDEN. I guess I have a different pagination.

Mr. ROSENZWEIG. Okay, it may very well be. I submitted it by

electronic mail and the pagination may have changed.

Chairman BIDEN. Is it the first chart you have where it says

‘‘Crime Type,’’ ‘‘Rate of Imprisonment,’’ ‘‘Fraud,’’ ‘‘Larceny,’’ ‘‘Immigration,’’ et cetera?

Mr. ROSENZWEIG. Yes.

Chairman BIDEN. Okay.

Mr. ROSENZWEIG. But as you can see, that applies to only some

11,000 individuals in fiscal year 2000, out of roughly 60,000 who

were sentenced. So this is only one-sixth, more or less, of the total

number of people sentenced. For most situations, either some congressional enactment, a mandatory minimum sentence for a drug

offense or some operational guidelines, didn’t afford the courts any

discretionary opportunity.

The other area in which we might expect or we might think that

we would see a bit of disparity would be in the rates of departure.

If the guidelines command sentencing, we might ask whether

judges are, for example, preferentially departing more frequently in

white collar cases than they are in street crime cases. That would

be the third chart I have, again ‘‘Rate of Departure,’’ and there

again there are some variations amongst the various types.

But when I went and pulled this data down, I was actually fairly

comfortably surprised to find that the rate of departure for robbery

is not appreciably different from the rate of departure for fraud.

Chairman BIDEN. For fraud, you have 9.2 percent; robbery, 12.7.

Mr. ROSENZWEIG. That is right, so in 12 percent of the cases

where the crime of conviction is robbery, nationwide judges are departing from the guideline range.
28

Chairman BIDEN. Now, when you say ‘‘depart,’’ did you make a

distinction of departing up or down?

Mr. ROSENZWEIG. These are downward departures. There were so

few upward departures——

Chairman BIDEN. I just wanted to make sure I had the facts.

That is all.

Mr. ROSENZWEIG. The data I am reporting are for downward departures, and I should add are exclusive of substantial assistance

departures, which are the predominate method by which departures are found. A defendant provides substantial assistance to the

Government and then the Government moves with for a departure

from the guidelines. These are departures for other reasons, ranging from extraordinary circumstances to——

Chairman BIDEN. I understand. I just wanted to make sure I understood.

Mr. ROSENZWEIG. So, taken together, these two pieces of data say

to me, at least, that when judges are exercising some form of discretion or choice, they are winding up not making too much of a

distinction in the way that they exercise and the frequency with

which they exercise discretion between white collar offenses and

street crime, blue collar offenses.

So that brings me back to the converse point, which is that then

the disparity in sentencing which remains that in the chart above

that, it is quite clear robbery sentences, drug trafficking sentences

are getting substantially longer mean and median sentences than

environmental sentences or antitrust sentences.

Those must be the product of the operation of either statutory

maximums or potentially the way the guidelines themselves are

structured. I agree with Professor Bowman that the amendments

from 2001 which are designed to alter the way we calculate loss

may go some way toward changing that, and I agree as well that

it is too early to tell.

The point I would add to the testimony of Mr. Skolnik is I agree

that a large fraction of this is a lack of resources for these difficult

cases. I am not so sure that it is necessarily that we are focusing

exclusively on street crime. I think sometimes we are also mis-focusing our efforts within the white collar crime area.

Professor John Coffee has talked about the technicalization of

criminal offenses, and therefore criminalization in areas which are

more appropriately treated civilly. Plainly, the situations that we

are discussing here today, the allegations against Enron, if proven,

don’t fit in that category. They are classic common law frauds that

are and ought to be punished severely if indeed proven to be true.

But part of it is that within this complex area, we sometimes misfocus the resources in areas where we are not being as effective.

I would urge this Subcommittee, if it could do one thing, to try

and ask the Federal agencies responsible for criminal law enforcement to make a better effort at assessing their effectiveness, assessing whether or not their resources are being used productively

in areas where, in fact, we are going to get the biggest bang for

the buck.

To date, we don’t try and measure that. We never try and draw

a line between enforcement and increased regulatory compliance,

for example. We count beans, we count numbers of prosecutions. As
29

I said in my written testimony, that would be as if the Metropolitan Police Department counted murder indictments without ever

asking whether or not they are actually lowering the murder rate.

That is our goal, that is everybody’s goal, is to deter crime and

lower the incidence of white collar crime.

I thank you for the opportunity to testify.

[The prepared statement of Mr. Rosenzweig appears as a submission for the record.]

Chairman BIDEN. Thank you very much. I think the last point

you make is a very good point. In fact, we do that all the time. We

have Texas talking about the number of death penalties without

ever examining whether or not they have impacted at all on the

murder rate, which they haven’t. So it is always an issue.

I would like to begin with you, Mr. Rosenzweig. I agree with the

bulk of what you had to say. I would like you to expand on what

you did not spend enough time on because of trying to accommodate me, the distinction between—you touched on it, but I would

like you to be more graphic, if you would—the distinction you make

in your written statement between the type of white collar offenses,

the white collar offense that is the one that basically is the Enron

type, which, as you say, could be referred to as a definition of fraud

by another name, and then the white collar offenses which you

argue are quite different that involve prosecution for violation of

rules and regulations that are part of a larger statutory structure.

Can you amplify on that a little bit?

Mr. ROSENZWEIG. Yes, I would be happy to. What I have in mind

is a trend that has grown increasingly in the criminal law over

roughly the last 50 years, in which we have seen basically a diminution of criminal standards of intent for some regulatory offenses

and in increasing trend toward prosecuting what I would perceive

as technical violations, to the detriment of looking at the more significant frauds.

Later in the testimony, I cited one example where some of this

is actually quite frequent in Medicare fraud. There are plainly two

types of Medicare fraud out there. There are instances plainly in

which HMOs and individual doctors are deliberately lying about

what services they are providing, taking Federal money as a result.

When caught, they deserve, like any other thief, to be prosecuted

in the same way.

Contrast that, however, with many doctors, some of whom are

leaving the profession because of this, who are genuinely confused

as to proper coding. There are literally 100,000 pages of Medicare

regulations. The average doctor gets 35 pounds of them on his desk

each year, in which he is supposed to code correctly.

The key, to my mind, to distinguishing between those lies in definitions of criminal intent. We have historically punished people

with specific intent to do a wrongful act harshly, and they deserve

such punishment. But, increasingly, we have adopted rules of construction that presume for small businessmen, doctors, knowledge

of the regulatory environment. And they, either through ignorance,

mistake——

Chairman BIDEN. Negligence.

Mr. ROSENZWEIG.—fail to come up to snuff. It is a bad use of our

resources, first off, because the true frauds don’t get prosecuted. I
30

think it also diminishes respect ultimately for the criminal law because we look at people who don’t have that same degree of moral

culpability and are deserving of punishment. Dr. Vargo is not one

of those people.

Chairman BIDEN. I appreciate the distinction. I think it is worth

keeping in mind.

I would like to ask all of you to respond now to the various questions I am going to ask. Each of you need not respond to every

question, but you are welcome to if you like.

The professor just indicated that depending on which crimes we

pursue and how we pursue them and what offenses we pursue, we

either enhance or diminish respect for the law. I remember as a

law student reading Jerome Frank’s Law and the Modern Mind

and this notion of a judicial myth and this idea that it matters that

people think that the system is fair. It matters that people think

that judges are totally objective. It matters when things occur intentionally or unintentionally that lead people to believe that neither exists, that it is neither fair nor that the judge is objective.

I think that applies here because the thing that you hear most

often here stated, whether it is true or not—and I think the testimony of our last two witnesses indicates that the disparity, at least

at the Federal level, is not nearly as extreme as it is perceived by

the average person. Having held so many hearings over the years

on criminal justice issues, how many times have we discussed this

issue of prosecutorial discretion as it relates to plea bargaining?

What I would like to raise with you, particularly former and

present prosecutors—and I would start with you, sir—is there any

data that indicate that white collar prosecutions are either pled

down considerably, allegations of white collar crime, either indictments or even failure to seek indictments are treated with any less

diligence than drug-related crimes or crimes of violence or other

economic crimes that the average person thinks of as non-white collar crime—burglary, robbery, et cetera.

Can anyone comment on that?

Mr. COMEY. Senator, I don’t know if a data set exists on that,

and I am sure we can check and get back to you, but it ought not

to happen. Under a longstanding Department of Justice policy, the

guidelines are supposed to be as restrictive for the prosecutor as

for the judge.

As I have told my people, if you don’t like the guidelines, that

is too bad. They should channel your discretion because you can’t

fact-bargain and you can’t charge-bargain. The Department of Justice policy since the so-called Thornburgh memo in 1989, which is

still in force, is that you must charge the most serious readily provable offense and the plea must be to that offense, and all relevant

conduct that is provable must be included in the sentence. So there

shouldn’t be any jacking around on the prosecutor’s end, which is

not to say it doesn’t happen.

Chairman BIDEN. I understand. It is an important point.

Mr. Skolnik, you look like you wanted to respond.

Mr. SKOLNIK. I think the question is a very good one, Mr. Chairman. A lot of the data we seem to cite tends to be anecdotal and

may or may not be accurate in looking at the big picture.
31

It is my impression at the State level that there are instances,

and I can recall some from my own State, where prosecutors have

been reluctant to take cases because of the significant burden that

it would impose on them. When we are talking about county prosecutors in many smaller communities, their staffs are really not

that large. Oftentimes, they even rely upon part-time deputy prosecutors.

So I think from an anecdotal standpoint, it is my perception that

if a State securities commissioner brings a county prosecutor a

rather complex, resource-intensive securities fraud case that you oftentimes will encounter some level of concern by the prosecutor and

they probably are going to wish that you would take it someplace

else, if not to the Federal level, maybe to a larger county.

Chairman BIDEN. Professor Bowman, you have been a State

prosecutor and a Federal prosecutor and you know the Federal system well. I am not sure if the last panel or this panel indicated

that, for good or for ill, sometimes we set a standard here. We raise

the Sentencing Guidelines and it puts pressure on every State in

the Nation to raise sentencing guidelines because people come

along and say, well, look, if this were in Federal court, they would

go to jail.

Sometimes, I have been responsible for that and it has had a

positive effect and sometimes it has not been as positive an effect.

I am sure it exists here, except the one place that I wonder about

is—and I am going to get to the resource question in a minute and

I would like you all to speak to that.

Since I have just begun this, I don’t have enough data to make

the kind of case I would ordinarily make or to make a judgment.

My impression is that the allocation of resources at the Federal

level, even though they may be disproportionately low to other allocations of resources in the criminal justice system—and that is arguable and I want to get to that issue in a moment—are considerably more than they are at the State level in most States.

Am I on the right track, Frank? Is that your experience, or do

you have any evidence from your academic endeavors to support

that?

Mr. BOWMAN. I have no data, Senator, but I think your observation is undoubtedly correct as a generality. As I indicated in my

written testimony, I was a deputy district attorney in Denver for

a number of years. In fact, I was for a while the only person in the

office who was specifically dedicated to doing anything remotely related to white collar crime.

The basic attitude of my office and of the police department—and

I am not criticizing this; it is just the culture that prevails—was

that paper crimes aren’t real crime; they are civil matters, regardless of the intent involved, and so forth and so on.

Some of that is cultural, and it is understandable when you are

in an office where the bulk of your work is, and is perceived to be,

response to crimes like murder and rape and robbery which have

so much more emotional appeal. Part of that response has to do

with a lack of expertise. Very few local prosecutors’ offices have the

expertise to engage in complex white collar prosecution.

Part of that is limitations on tax dollars that flow to them. Some

of that probably is political in the sense that if you are an elected
32

district attorney, the mileage is in the high-profile murder case and

probably in some relatively obscure group of financial crimes.

But for a lot of reasons, all of which I am sure you are very familiar with in your many years of work on this area, local prosecutors tend not to do this kind of work, and therefore it becomes particularly incumbent, in my view, on the Federal Government to

take the lead because in most places and most times we are the

only game in town.

For most local prosecutors, if they come across a big case and

they really perceive that it has some criminal value, their instant

reflex is to call the U.S. Attorney’s Office and say this is your job,

guys, you take it.

Chairman BIDEN. That is my experience. My son is a Federal

prosecutor, although he was on the criminal side in Philadelphia,

which is a gigantic office, as you know, Mr. Comey. The gentleman

sitting behind me was a Federal prosecutor at the Justice Department for some extended period of time.

One of the things I would like to raise—and these are not accusations. I want to make that clear because this is a dangerous—I

quite frankly wrestled with whether to have this hearing, in light

of Enron and a lot of other things, because I want to be as sober

about this as I possibly can, which I hope I have been on other

matters relating to the criminal justice system. My impression is

there is another factor.

I know, Professor, you may have wanted to comment on that last

point, and if you will hold the thought, I just want to pursue this

one piece.

One of the reasons why local law enforcement and local prosecutors may not proceed and assume that it is the Federal Government’s job, and I raise this as a question—is in some States and

localities, proceeding against the county’s largest employer or proceeding against the county’s most prominent citizen who has donated everything from the playground to the opera house, especially since it is an uncharted area and not knowing how to proceed

very well, is a place people tend to not want to go, my instinct tells

me.

I would like your opinions on that. Is there sort of a limiting aspect to the instinct to proceed at a local level or even at a State

level? For example, I bring down frequently the lead Medicare

fraud folks we have at the Justice Department. We have one of the

best in Philadelphia, I mean really a first-rate team, and we have

one in California and the Southern District. There are some that

are particularly well-known and you use around the country. I actually bring them down to do seminars for local law enforcement

and for senior communities as to what to look for.

There is not a lot of reluctance to go after Dr. Smith, who has

billed falsely 3,000 mammograms or whatever. There is a reluctance to go after the xyz hospital, which is sometimes the biggest

employer in a community, in a city, in a county. I wonder whether

or not that plays. How would you guys factor this in?

The reason I bother to ask you this is I am not looking to indict

local officials in any way, but figure out the resource allocation

here. Should we be, for example, kind of like the crime bill, which

you probably don’t like—the Heritage Foundation, I mean—should
33

we be out there saying to local law enforcement and local prosecutors that at the Federal level, so not everything bubbles up to us,

we will have an amendment to the crime bill—I am not suggesting

one—to provide you ‘‘x’’ number of dollars to hire prosecutors to

pursue white collar crime?

Or should we be saying to Main Justice we want to enhance your

budget, so that we are going to increase the funding that provides

you the ability to hire ‘‘x’’ number more prosecutors, investigators,

accountants, and the various technical people you need in order to

be able to pursue white collar crime?

That is why I am asking these questions, so you don’t think it

is just an exercise in futility here, to try to get the best sense of

which way, if at all—and maybe we shouldn’t be doing anything

more; that is, we who sit up here in the Congress, in terms of either changing the penalties, changing the guidelines, changing the

allocation of resources. So that is why I ask the question. Sorry for

the long prelude.

So can you comment for me instinctively on what you think,

based on your experience? We will start with you, Frank, and then

I know, Professor, you had something you wanted to say, and anyone else who wants to respond. If you have no response, that is

okay, too.

Mr. BOWMAN. Two quick observations. One, I think your instinct

that, again, as a broad generalization and supported by no data

and only my own personal experience—one way or another, I have

been either an actual, full-time or special assistant U.S. Attorney

in three different districts around the country, and I have been a

deputy D.A. in Denver, and so forth and so on.

Based on my limited personal experience, I think your perception

that local officials sometimes feel constrained to bring white collar

and other types of cases, including, for example, public corruption,

feel more constrained than perhaps their Federal counterparts

might—I think that is, as a generalization, probably not at all unfair.

I think that Federal prosecutors sometimes see themselves—I

certainly did—as sort of the force of last resort to deal with sometimes locally intractable problems. So I think that your instinct is

certainly consistent with my experience, though I can’t prove that

that is true.

The second part of your question I take to be sort of from a resource perspective what would be the best thing to do if we had the

money and the will to do it. My own sense is that certainly at the

Federal level, the Federal effort would benefit from an increased allocation of resources.

There is always, of course, the problem with which you are certainly more familiar than I of making sure that money that is appropriated in Congress is spent for the purpose for which you wish

it spent. But I think there are some models historically with respect to the Department of Justice in the white collar area to which

you might look—the additional sums that were allocated in the

wake of the savings and loan scandal, the additional sums that

were allocated to beef up the health care fraud initiatives in the

Department.
34

I am not familiar with the specifics of the legislation, but my understanding is that certain restrictions were placed on how the Department allocated those funds.

Chairman BIDEN. They were.

Mr. BOWMAN. That is obviously a model to which one could look,

although in this particular case what we are talking about, it

seems to me, is a somewhat broader question, white collar crime

more generally, and how you would craft that legislation to get the

money to the place you want it to go is beyond my competence.

Chairman BIDEN. That has never slowed up any Senator.

Mr. BOWMAN. The last suggestion you make is an interesting one

which I had never thought of before, the notion of some sort of

funding passing through the Department or some other entity to

States.

Chairman BIDEN. We have done it clearly on the violent crime

side of the equation. We have done it clearly in other areas, so it

is not unique.

Mr. BOWMAN. It sounds like a tremendously intriguing idea, and

thinking completely off the top of my head and spontaneously the

only impediments perhaps that one might see are, at least in the

violent crime area if you are giving local prosecutors more money,

you are giving them more money to do something they already

know how to do.

Chairman BIDEN. Correct.

Mr. BOWMAN. They know how to do it and they know how to

train people to do it. If you give them more money to do something

they don’t know how to do, they may be a little bit more reluctant.

I also think that perhaps it may be difficult to give them sufficient funding to train and keep the kinds of people with the kinds

of skills that you need to do this kind of crime and keep over the

long term, because people who develop those kinds of skills become

very valuable in the marketplace and may be easily drawn away

from the relatively low-paid positions in local D.A.s’ offices.

Chairman BIDEN. Let me give you all a statistic and invite you

all to comment on that point, but just a statistic that relates. There

were about five of us who held extensive hearings in different Committees during the late 1980s and 1990s about the extent of health

care fraud, for example.

Depending on whose model you pick, it is somewhere well above

$500 billion and as a high as $1.1 trillion. I mean, it is a lot of

money, it is a lot of money. Some estimates indicate that the losses

to fraud were as great as 10 percent of—let me be precise. I am

sorry. In 1999, health care expenditures in the United States were

$1.1 trillion. I misspoke.

The estimates are that about 10 percent of that expenditure was

as a consequence of fraud. So we passed an Act that was called the

Health Insurance Portability and Accountability Act, in 1996,

which made funds available for more FBI agents and attorneys

designated specifically to investigate and prosecute health care

fraud cases. We thought this may be a place for savings because

we are worried about Medicare costs.

As a consequence, the FBI, from 1996 on, increased the number

of agents assigned to health care fraud from 112, in 1992, to 500

in 1999. The number of active health care fraud investigations in-
35

creased from 592 to over 3,000, and convictions increased from 116

to 548.

Now, while these numbers are impressive, we should obviously

be cautious about how we interpret this data in terms of how it relates to other things. But I cite that to indicate what I know you

know, Mr. Comey, and others that this is not the first time that

this idea has crossed my mind about the possibilities of how to do

this. I think it is more complicated here, but it is just something

I wanted to raise with you.

Does anyone want to comment on anything that has been said

so far? Mr. Skolnik?

Mr. SKOLNIK. Mr. Chairman, I would like to comment on the

question you asked regarding the possible reluctance of local prosecutors or investigators to take on a case when it may involve a

prominent citizen or a corporate citizen within their community.

It is my impression that local and state prosecutors or enforcement agencies are more apt to be constrained by a lack of resources

than any local pressures in terms of why they don’t bring a case.

For example, I have always made it very clear to my staff that we

don’t shy away from a case just because it involves a prominent

member of the community or a local corporate citizen. I think that

is something generally law enforcement throughout the country

does very well.

If I may differ with my fellow Hoosier here, Professor Bowman,

I do believe that, if appropriately funded and provided adequate resources, local and state prosecutors and investigative agencies such

as mine can do the job in terms of developing and investigating

white collar crime cases.

Chairman BIDEN. I would connect the two comments you made

and again invite comments on this. I would connect the lack of resources and the reluctance to go after the big fellow because you

don’t want to wound the bear. It is one thing if you go after somebody who is viewed as a charlatan in the community and is not responsible for the employment of a lot of people. And you are not

sure you have the investigative tools to get the job done, but there

is a tendency to be willing to start it.

But if you don’t have the investigative tools and if you don’t have

the resources, you sure don’t want to go after xyz corporation,

where the corporate leadership sits on the board of the cathedral

and the symphony or whatever. That is all I meant. I wasn’t suggesting that I think local prosecutors or regulators sit and say, oh,

my God, I don’t want to take on xyz corporation.

I just think it is related to resources because like I said, you just

don’t want to miss. If you miss with somebody who already doesn’t

have much standing in the community, then the criticism to you

and your department is much less severe than if you take on an

entity that is a vaulted entity. That is all I meant. I wasn’t going

to motive about resolve or political courage.

Mr. Comey, you indicated and accurately stated that every U.S.

Attorney’s office sets guidelines that direct its attorneys’ prosecutorial decisions. For example, in many instances these guidelines

contain dollar amount limits that effectively discourage prosecution

of economic crimes that result in dollar losses below a certain

amount.
36

That is a legitimate thing for the Federal Government to do. I

mean, we shouldn’t be handling every nickel-and-dime crime. I am

not suggesting that, but I want to make sure we know what we are

talking about here. Let’s say the dollar amount is $100,000.

Investigators take their cues from prosecutors’ offices. If a case

will not be prosecuted, you don’t have the FBI or the local folks in

that area investigating the case. So I am concerned about the type

and the number of cases that, as a consequence of decisions not to

prosecute, potentially fall through the cracks. It may be a case

much bigger than $100,000, but if it just appears on the surface

that that is the extent of the loss, the investigation that may uncover a greater cancer out there is not undertaken. A $100,000 loss to the two people who were here in front of us today—granted, they are part of a larger whole, but a $100,000 loss

to them is the beginning, middle, and end of their existence, in

their view, but may not be significant enough to get us into the

deal. It is these relatively smaller dollar amount frauds that are

the most widespread out there. Hopefully, pray God, we will not

find out that they are all of Enron proportion not in terms of guilt,

but in terms of dollars.

So what happens in the cases that don’t get the attention of federal prosecutors? Are they picked up by State prosecutors?

We always talk about it going one way. We on the Federal side,

people like yourself and my staff members who were prosecutors

and my son, talk about the local authorities coming to them saying,

hey, look, this is a big deal, we need your heft here.

But how often do we go the other route? How often does, say, an

FBI agent or an investigator come to a U.S. Attorney or an Assistant U.S. Attorney and say, look, I think we have got a scam going

here and they are defrauding a whole lot of people, but is not prosecutable under our guidelines here? How often does somebody pick

up the phone and call the district attorney, the county attorney,

the county prosecutor, the State prosecutor?

Does the question make any sense here?

Mr. ROSENZWEIG. In my experience, when I was with the Department of Justice, it was a fairly common two-way street. I think,

frankly, it will depend a great deal upon the particular relationships between a U.S. Attorney and a county prosecutor in various

localities, which could easily turn on a whole host of factors that

are utterly unrelated to the merits.

On a number of occasions that I found cases that didn’t seem to

warrant Federal concern, where I found there were still apparent

violations of State and local law, both I and the investigators I

worked with were happy to put them over.

Chairman BIDEN. Does anyone else have a view on that?

Mr. COMEY. Mr. Chairman, that is my experience, as well, both

in a small U.S. Attorney’s office and now in a very big one, that

there are often cases moving in both directions. The Federal prosecutors need to be sensitive in doing it because they don’t want

their State colleagues to think that a smelly dog goes to the State

and something that is significant goes to the feds.

Every good U.S. Attorney’s office uses those guidelines as just

that, guidelines. If the FBI says what you just said, which is there

may be a lot of victims here and it may go farther, any AUSA
37

worth his stripes is going to take that case, regardless of what the

loss amount looks to be on its face.

Chairman BIDEN. I have trespassed on your time a lot here. I

promise you will be out of here by one, okay? It is ten of.

What about this notion of resources? Everyone I have ever spoken to comes back to a place where they say, hey, look, the more

complicated the case, the greater the resources needed.

Look, let’s face it. You guys have a problem right now and it is

not of your doing. We are reallocating—and we should, no disagreement—a lot of investigative resources to terrorism. At the same

time, if you are able to overcome the disagreement with the paradigm that the Federal Government should be involved in local law

enforcement through a crime bill and through funding cops, et

cetera, we are also cutting substantially, essentially eliminating,

money for local law enforcement.

You are going to have fewer cops. You are going to have less

money for Byrne grants. You are going to have less money for investigative tools on the law enforcement side; considerably less, I

might add, about 80 percent fewer dollars, flowing from the Federal level directly to hiring of cops, et cetera.

At the same time as we pull 570 FBI agents, or whatever the

number is, out of violent crime task forces, which your guys rely

on a lot—I mean, they have been very helpful and you have done

very well, in my view, at Justice—I think we have a resource problem that is further complicated by the plight our country faces now

in dealing with terror and terrorism.

So I am a little concerned here—this is kind of above all of our

pay grades here, but I am a little concerned that we continue to

think we can do more with the same resources. That is the argument being made, by the way, today by many: We really don’t have

to increase the number of FBI agents, we don’t have to increase the

number of DEA agents, we don’t have to increase the number of

CIA agents; we just do it better and we are going to cover all of

these areas.

So when you take whatever the number is, 500-plus, FBI investigators out of violent crime task forces and other areas—they are

obviously not going to white collar crime and I am not arguing they

shouldn’t go to terrorism—and the FBI makes the judgment that

we are not going to be in the business of dealing with local law enforcement issues as much as we did before—i.e., interstate car

theft, bank robbery, et cetera, local issues—and we are not going

to fund to the tune of well over $1 billion a year local law enforcement any longer, if that prevails, I think we have a problem sitting

here talking about white collar crime resources.

Can my staff put up the number of white collar crime cases?

If you look at the number of white collar crime cases referred by

the FBI since 1993, it has dropped from 21,000 to under 13,000.

Now, that may be because there is a lot less white collar crime out

there. My instinct tells me that is probably not true. I have no data

to prove that is not true.

I see you looking as if that may be wrong.

Mr. BOWMAN. I don’t know whether it is wrong or not. It strikes

me as an odd graphic only because last night I was looking at the

number of convictions reflected in Sentencing Commission data be-
38

tween 1992 and the present, and although the number hasn’t gone

up by a lot, it has gone up. So I think you have about maybe 2,000

more convictions in the year 2000 than you did in 1992 for crimes

broadly under the economic crime rubric.

Chairman BIDEN. Well, it may very well be that with the 21,000

cases—this is what I am trying to get at here—the 21,000 cases referred in 1993 were so complex they couldn’t make the case and

they have gone down to 13,000 because now they are taking much

less complex cases and increasing the allocation of resources available to focus on those cases and make the case.

Again, I ask staff, is there any doubt that this statistic is correct?

And there is that old admonition that there are three kinds of

lies—lies, damn lies, and statistics.

This statistic is correct, and the only explanation I could come up

with because I am aware, also, that the number of convictions is

up, is it is very possible that there is more cherry-picking going on

here, that we are picking those cases that are easier to make, or

are hard to make, but we have fewer resources focusing on them.

But the bottom line is either one of two things has happened—

or three. The statistic is wrong, number one. Number two, the

cases that were being referred were frivolous in 1993 and we are

now down to a realistic area. Or, three, there has been a conscious

decision to only refer cases that reach a certain threshold and allocate the resources to the cases that reach that threshold. There

may be other explanations, but there needs to be an explanation,

it seems to me.

Now, the percentage of offenders receiving probation in fiscal

year 2000—again, we are talking the percentage receiving probation. We are not talking about those who got sentenced, whether

the sentence they received is as disparate as the probation is.

But as I understand it—and this is at the Federal level, the Federal Sentencing Commission—1.5 percent, robbery; 5.2, immigration; 7.8, burglary; embezzlement, 41 percent; fraud, 33 percent;

larceny, 56 percent. For larceny cases, for example, before the Federal Government, under the Sentencing Guidelines, 56 percent of

them convicted of larceny got probation.

Now, again, I am not looking to make a case. I am looking to explain the circumstances because I am going back to this notion that

if the public thinks that the system is not fair, that people who

steal from them are not getting the same kind of time if they wear

a white collar—and it is not necessarily all white collar, although

most of it, I suspect is—are not getting the same treatment as

somebody who burglarizes their home, then there is a bit of a problem.

Yes?

Mr. ROSENZWEIG. Well, I have the same data. First, in general,

that is right. I think it is important to note that in defining the

number of people who have gotten probation in the white collar

area and in the non-white collar area, the data you present combines the number of people who get only probation with the number of people who get both probation and a term of confinement.

Chairman BIDEN. Important point.

Mr. ROSENZWEIG. So it slightly overstates in all six things the

number of people who are receiving straight, pure probation.
39

Chairman BIDEN. The same standard was applied to all, though.

Mr. ROSENZWEIG. Yes, the same standards apply to all.

Chairman BIDEN. But it is an important point.

Mr. ROSENZWEIG. So as a gross number, it is a bit misleading as

a gross percentage. The other point I would make is that I think

this goes back to what I was testifying about earlier, which is from

my perspective the real reason that there is a very low number in

the non-white collar area is that the guidelines prohibit probation

for most of those offenses and they make it available in a large

number of white-collar offenses.

Chairman BIDEN. Which is the larger point. The other point here

is that according to the 2000 Sourcebook for Federal Sentencing

Statistics, the mean in terms of months for robbery is 108.1

months; for burglary, 26.5 months; auto theft, 46.6 months; larceny, 7.9 months; fraud, 13 months; embezzlement, 7.2 months.

So, again, the point Professor Rosenzweig was making: It may

fall to us here and/or the guidelines, not to the judges, as to whether or not this discrepancy exists, to the extent that it exists.

What I am going to do, in the interest of keeping my commitment to you on time, is submit some questions to you, if I may, not

a lot, to try to flesh this out a little bit more; that is, this notion

is it really, in fact, appropriately balanced here.

Lastly, one of the things we didn’t speak to and I would be interested in your comments on—and I will let you go with this—is you

gave us mean numbers for the Nation nationally and the extent to

which discrepancy exists. But if we look at the Federal fraud offenses from various districts, the districts vary widely.

Now, I don’t know enough to tell you whether or not these fraud

offenses vary so widely because the enormity of the offense varies

widely. Do you follow me? I don’t know enough to know that at this

point. That may be part of it. Again, this is not to make a case;

this is to raise a question.

For example, in Rhode Island, the average in terms of the number of months for Federal fraud convictions in 2000 was 12 months.

In northern Indiana, it was 32 months. Again, we may be comparing apples and oranges. I would like to just take Rhode Island and

Indiana, just those two jurisdictions, and I am going to ask my

staff to go back and compare the type of fraud offenses and whether or not they are the same, on balance.

I will start with you, Mr. Comey, as the guy who has folks all

over the country in every jurisdiction. Do you find that there is a

difference, that the standards vary fairly considerably?

Mr. COMEY. In terms of intake of cases?

Chairman BIDEN. In terms of average prison terms for similar

cases.

Mr. COMEY. My sense is that it does. It may be a number of people contributing to that, including the court. There are number of

circuits in this country that depart at a much greater rate than my

former circuit. For example, the Fourth Circuit; you don’t get a

downward departure in the Fourth Circuit.

But it may also, as you pointed out, Senator, depend upon the

case mix. It may be that certain jurisdictions are responding to a

rash of small embezzlements by tellers, and so there have been a
40

lot of fast-track bank cases. Indiana may have done a couple of

huge cases and devoted their resources to that.

Chairman BIDEN. There are a number of reasons this departure

could take place, and that is why I am going to submit these questions. The number of cases prosecuted in Rhode Island, for example, is only 18. The number of cases prosecuted in, for example, the

Western District of New York was 48. Larger districts have larger

budgets that enable them to have special task forces. The paucity

of white collar crime and the predominance of other threats in certain districts.

So there are a lot of reasons, but I guess what I am trying to

do here—and I hope it is obvious to you because I know this is a

very serious panel—is trying to do this in a sober and thoughtful

way so that we don’t have a cure that is worse than the problem

out there.

I am a cosponsor of S. 2010. I agree with you that it makes some

good sense, but I think, if nothing else, one of the jobs that we

should exercise here is to educate the public. If it turns out that

there isn’t this vast discrepancy as perceived, then we should let

people know that, again because I think it is very important that

there is this sense of the average person thinking the system is fair

and the system treats people equally and equitably.

So this is just our first hearing. This is not going to be dragged

out for any extended period of time, but I have to figure out where

the inequities lie here, and in the process, if it turns out there is

not this vast discrepancy, then make sure the public knows it and

the press knows it so that we can reinstate some confidence in the

system, and if there is a vast discrepancy, fix it.

I have some questions for my two colleagues from Indiana and

West Virginia, who have positions of authority there, that I will

put in writing relative to resources and whether or not you think

there is any Federal role that we have here.

I also am going to ask you, Mr. Comey, some questions, obviously

you will have to kick upstairs, about resources at Justice. And I am

prepared to ask all of you this—I don’t want to put work on you,

but I would ask the two colleagues at the end of the table here, Mr.

Bowman and Mr. Rosenzweig, about the notion of deterrence.

Again, the general impression most people have is a white collar

criminal is usually deterred by their first offense, if they get jail.

And the argument I have heard often, and I have heard prosecutors make it, is, hey, look, this person had standing in the community and the mere fact that they have been convicted is enough of

a deterrence and they are never going to do it again, even though

they don’t go to jail, whereas you may have to put the guy who

clunked somebody on the head and took their wallet in jail for a

long time because he has done it three more times and the recidivism rate is so high. That is why we make the penalty higher.

So I have some questions drafted and I would like to talk about

deterrence, recidivism, and severity of the punishment, and whether there is or should be a relationship. I am going to ask that to

the Justice Department, as well.

I am sorry. It is eight minutes after, but I apologize. I am truly

thankful that you all are here. You are first-rate panel, and with
41

your permission I may trespass on your time again before this is

all over, if you are willing. Gentlemen, thank you very, very much.

There is a statement for the record by Senator Breaux, who is

Chairman of the Special Committee on Aging. He has been engaged in issues that relate to the elderly population. I want that

in the record.

Senator Grassley has a statement, as well, and some questions.

We also have statements by Senator Leahy and Senator Hatch.

And they may, I warn you, have a few questions for you, but we

are not going to try to make too much work for you.

We are adjourned.

[Whereupon, at 1:09 p.m., the Subcommittee was adjourned.]

[Questions and answers and submissions for the record follow.]
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(163)

PENALTIES FOR WHITE COLLAR OFFENSES:

ARE WE REALLY GETTING TOUGH ON CRIME?

WEDNESDAY, JULY 10, 2002

UNITED STATES SENATE, SUBCOMMITTEE ON CRIME AND DRUGS, COMMITTEE ON THE JUDICIARY, Washington, D.C.

The subcommittee met, pursuant to notice, at 2:34 p.m., in room

SD–226, Dirksen Senate Office Building, Hon. Joseph R. Biden, Jr.,

Chairman of the Subcommittee, presiding.

Present: Senators Biden, Durbin, Grassley, and Sessions.

OPENING STATEMENT OF HON. JOSEPH R. BIDEN, JR., A U.S.

SENATOR FROM THE STATE OF DELAWARE

Chairman BIDEN. The hearing will come to order. We thank our

witnesses for being here, and those in the audience. Senator Grassley and I are each going to make relatively brief opening statements and then turn it over to our witnesses.

We are now in a period of, I guess it would not be an exaggeration to say, if not a major, a minor reevaluation on how we do business in America. The thing that I would like to point out before I

begin this hearing is this is not merely about stockholders who

have been defrauded. This is not merely about employees who have

lost their jobs. This is not merely about the wrongdoing of individuals. Quite frankly, and it is not hyperbole, this is about the capitalist system. It all rests on the notion of transparency, period.

If, when you go to purchase a stock, you do not have any reliable

public information that gives you an ability to make an educated

guess as to what the prospects of that company are based on its

assets, its liability, its product, the market, the time, the environment, then you might as well go play the lottery instead of buying

stock. Go play the lottery.

It is not an accident that Europeans are for the moment

disinvesting in this country. It is not an accident that the American

Business Roundtable, the sort of bogeyman—not in my State, the

corporate State of America, but the bogeyman of sort of the conspiratorial theories, the trilateralist opponents kind of thing—it is

not a mistake that the Business Roundtable sent a letter to me.

‘‘Dear Senator Biden, I am writing on behalf of the Business

Roundtable to urge you to vote for Senate bill S. 2673, the Public

Company Accounting Reform and Investors Act of 2002.’’

This didn’t come from the Consumers Union of America. This

didn’t come from a group of new world, new order types. This is

the establishment of the established business interests in the
164

world, and they have it right because guess what? There have been

an awful lot of driveby shootings.

You have companies as old, as honorable, and as sound as the

DuPont Company opening up their 200th stockholders meeting and

an honorable guy, chairman of the board, starting off by saying ‘‘By

the way, I want to make it clear to you we aren’t one of those guys.

Think of that, think of that.’’

So we need to look at how this economy is run. The problems we

confront range across the width and breadth of business activities.

We have Enron, WorldCom, Martha Stewart, Xerox, Rite Aid, all

in varying degrees of collapse or difficulty, and the list goes on and

on of people and corporations admitting cooking the books or being

accused of inside deals.

We need to ask, as someone else said, are the capitalists killing

capitalism? I expect the dialogue to last beyond this session of Congress. Everyday, people come up to me in my State and say, ‘‘Joe,

you have to do something.’’

If I ever thought, Senator Grassley, that I would be going to

Fourth of July parades in my State—this is the God’s truth, and

you probably experienced the same thing—whether it is in

Hockessin, Delaware, or down in Laurel, Delaware, and people saying to me, ‘‘You know, I own stock in my 401(k).’’ These are bluecollar workers, not just white-collar workers. ‘‘I lost this, that, or

the other thing. What are you going to do about those guys?’’

I haven’t had this much spontaneous concern expressed to me

and calls for penalties for wrongdoers, as the President might

say—I haven’t had this much since the beginning of the drug epidemic in this country.

Everyday, as I said, people want to know what we are going to

do. They are concerned about a climate of corporate greed and overreaching and what appears to be the loss of an ethical framework

in some American corporate board rooms. They are concerned

about corporate stock options, the vast amount of money executives

make, and the way incentives are structured for CEOs to walk

away from failing companies.

I support Senator Levin’s legislation, which requires stock options to be clearly listed as a corporate expense, a position already

endorsed by Alan Greenspan and Warren Buffet.

Delawareans are concerned about how our tax treaties are written to give inappropriate encouragement to companies to move

overseas to avoid taxes. I listened to a Wall Street analyst as I was

shaving, leaving my house this morning, on CNN, who was asked

about the President’s speech. The response he gave was, you know,

we have created—how do you phrase it—a climate for corporate

greed. This was a Wall Street analyst.

As my mother would say, and the nuns that taught me, Joe, you

have to avoid the occasions of sin. They usually meant girls back

then, the nuns, but the truth of the matter is we present a lot of

occasions of sin for corporate executives. The incentive that we

place before them is one that the vast majority resist, but it is to

take actions that are counterintuitive to the interests of their

stockholders.

Delawareans are concerned about providing more transparency

and accountability so when you want to buy a stock that is a good,
165

safe investment, you know the books aren’t cooked. That is why I

support Senator Sarbanes’ bill, as the Business Roundtable suggests that we should, that is on the floor today.

If you are an employee, you need to know that your pension is

safe, and if there are real hard criminal penalties if it is not, then

you have got a better fighting chance that it stays safe. That is

why I joined Senator Leahy in offering an amendment to strengthen the criminal penalties for what are now white collar crime misdemeanors. So if you steal a pension, you go to jail, no different

than if you steal a car.

I live about 2 miles from the State line and if you steal a car out

of my driveway and you drive it across into Pennsylvania, 10 years,

Federal guidelines. If you take a pension by violating ERISA, the

Federal system to safeguard pensions, misdemeanor, maximum one

year. The pension may be worth $1,800,000. My car may be worth

$2,000, and if you saw the car I drive, you would know why I say

that.

Today, we are voting on the floor of the Senate to address a lot

of these concerns, specifically honesty and trustworthiness of the

reports that are provided by accounting firms about what is going

on inside corporate America.

I will offer an amendment today to restore the power of stockholders to bring lawsuits against executives who distort and inflate

the value of their company, misleading investors and setting them

up to fail. That is why it is so important here today that we hear

from witnesses who will help us examine many of the issues in

terms of criminal and civil enforcement of the laws governing how

we do business, and we do have a very, very distinguished panel

for that purpose.

Before I introduce them, I will yield to my colleague from Iowa,

Senator Grassley, for any comments he wishes to make, and then

we will go with the witnesses.

STATEMENT OF HON. CHARLES E. GRASSLEY, A U.S. SENATOR

FROM THE STATE OF IOWA

Senator GRASSLEY. Mr. Chairman, I wasn’t in any parades over

the holiday week recess, but I did have town meetings in 14 counties of northwest Iowa and this issue did come up at many of those

meetings, if not all of those meetings, because it was on people’s

minds.

First of all, I want to make very clear that I appreciated the

President’s speech yesterday. For those who have been somewhat

critical of it, I want to suggest that the President did not say that

there were any ideas before Congress that he would oppose. Now,

he might oppose some. I don’t know, but he didn’t that there were

any before Congress he would oppose.

Obviously, he suggested a lot of legislative responses himself,

and I think the President is going to feel comfortable signing legislation that we pass. I have never seen the President not willing to

listen to Congress and work with Congress on this issue. So I applaud the President for speaking out and setting a very, very good

tone.

We have listened about this issue in a previous hearing and we

have had the issue raised about white collar crime, whether or not
166

criminals are punished less severely if they are white collar criminals than other criminals. Many legal scholars and others believe

that white collar offenders are rarely prosecuted. We need to get

to the bottom of this and ask why and what we can do about it.

I think a message needs to be sent that white collar crime, especially as it relates to fraud, is serious and carries significant penalties. This is an area where we need to be even tougher on criminals. I am very happy that the President is taking the lead in setting up the Financial Crime Swat Team, because this means that

the President is not going to wait for Congress to act before he can

do what he can under his own authority and what the Justice Department can do.

I also want to emphasize that we need to look into the problems

of accounting standards and business ethics systems. There needs

to be a revival of business ethics in today’s corporate world, and

legislation that we pass will not guarantee that. It will guarantee

punishment when things that are criminal happen.

But we need to have, as evidenced by the letter the chairman has

referred to, as well as ads that were in yesterday’s Post, as an example, business leaders themselves see that there is a real need for

people at the top of the business world to set good standards, and

a promise from those people that are involved with those ads, at

least, that there will be that leadership to do that.

Now, I want to concentrate on one last point more in depth than

the three or four things that I have mentioned, because this is

something the chairman knows I really believe in.

Most of the time when I talk about whistleblowers, it is in regard

to government service and people that are in public service blowing

the whistle on wrongdoing. But I think one important way to protect investors is to ensure that corporate whistleblowers will be

protected from retaliation when they go public with knowledge of

fraud.

For nearly two decades, I have come to appreciate and honor

whistleblowers, not meaning that everybody that comes before Congress or before me has a legitimate position. But I think that we

need to be open to at least listening to what those positions are because there is an awful lot to learn. Only whistleblowers can explain why something is wrong and provide evidence to prove it.

Then we can fix the problem and hold miscreants responsible.

Only whistleblowers can help us understand the culture that produces wrongful behavior. Understanding the culture is the key to

fixing the problem and realizing meaningful institutional reform.

In that regard, I consider whistleblowers national assets.

In the context of corporate wrongdoing, whistleblowers can provide the evidence that prosecutors need to build a case against corporate criminals. Without these brave men and women, prosecutors

would lack an important tool in their efforts to curb corporate

fraud.

It is for these reasons that I have worked to provide protections

for corporate whistleblowers, as well as Federal Government whistleblowers, who are retaliated against for exposing fraud, waste

and abuse. Because whistleblowers are so important to cracking

down on corporate fraud, I asked Mr. Tom Devine, from the Gov-
167

ernment Accountability Project, to come and testify, and I will wait

for him to summarize what he has to say.

Mr. Chairman, I didn’t read my entire statement. I would like to

have it all put in the record.

Chairman BIDEN. It will be pleased in the record.

[The prepared statement of Senator Grassley appears as a submission for the record.]

Chairman BIDEN. Let me introduce our first panel and welcome

back Mr. Chertoff, who is the Assistant Attorney General in charge

of the Criminal Division of the Department of Justice.

He has served as U.S. Attorney for New Jersey from 1990 to

1994, and before being nominated to his current position he was a

partner in Latham and Watkins. Mr. Chertoff is a graduate of Harvard University undergraduate, as well as the law school, a man

who knows of what he speaks.

I kidded him before we began by saying it is a good time to have

this job. What is that old curse? May you live in interesting times.

You are in interesting times. We thank you for being here and we

appreciate the balance you always bring to this committee.

Mr. William W. Mercer is the United States Attorney for the District of Montana and head of the Department of Justice’s White

Collar Crime Working Group. Mr. Mercer had seven years of experience as Assistant U.S. Attorney before he became the U.S. Attorney. He has an undergraduate degree from Harvard, and also a

law degree, and we welcome him here as well.

Gentlemen, the floor is yours, if you will proceed in any order

you would like to. Michael, you fire away.

STATEMENT OF MICHAEL CHERTOFF, ASSISTANT ATTORNEY

GENERAL, CRIMINAL DIVISION, DEPARTMENT OF JUSTICE,

WASHINGTON, D.C.

Mr. CHERTOFF. Thank you, Mr. Chairman, Senator Grassley. I

would like to thank you for inviting Bill Mercer and myself to appear here. Bill is also the chairman of the Subcommittee on Sentencing of the Attorney General’s Advisory Committee of U.S. Attorneys. Both of us welcome the opportunity to appear today to continue the discussion about what this administration has done, is

doing, and intends to do to detect, punish, and deter white collar

crime.

Yesterday, the President travelled to New York and called for a

new ethic of corporate responsibility. Although most business people do play by the rules, some do not, and we are reminded again

recently of the serious damage to people’s trust and confidence in

our economy that this type of wrongdoing fosters. The President’s

proposals would give prosecutors important new weapons in the

fight against this kind of white collar crime.

As I know you are aware, we have not hesitated at the Department of Justice to proceed with criminal cases against corporate executives, accountants, and others who have abused their positions

of trust and authority for personal gain or for other improper purposes by breaking the law.

Indeed, until recently some people were calling us too aggressive

in pursuing these criminal cases. Not surprisingly, those voices of
168

criticism seem to be growing more faint as evermore egregious

business practices are exposed to public scrutiny.

I am proud of the work we have done and continue to do both

here in Washington and at the many U.S. Attorneys’ offices around

the country, where Justice Department prosecutors and FBI agents

are going after corporate crooks everyday. We have made a lot of

progress, but we have a lot left to do.

In the meantime, this administration is sending a very clear

message: fraud, obstruction of justice, and other types of criminal

activity in the business world will not go unpunished or receive

merely a slap on the wrist. To the contrary, robust enforcement of

the law gives people both on Wall Street and Main Street confidence that the financial marketplace and our economy in general

will continue to operate under principles of honesty, integrity, and

trust. That is a message that most honest, hard-working people in

the business community have welcomed and one that will give the

American people renewed faith in our economic system and our

criminal justice system.

The President’s proposals would both increase the ability of

agents and prosecutors to catch white collar criminals and stiffen

the penalties for offenders when they are convicted. Let me take

a moment to highlight some very specific proposals as they relate

to criminal law enforcement.

First, the President has ordered the formation of a corporate

fraud task force within the Department of Justice which will be

chaired by the Deputy Attorney General and of which I will also

be a member. The task force will provide direction for the investigation and prosecution of white collar crimes, including significant cases of securities fraud, accounting fraud, and other financial

misbehavior. The task force will also actively work to improve cooperation with other Federal agencies and State authorities, and

will recommend policy and legislative changes as appropriate.

Second, the President has called for increased white collar penalties, including measures to ensure that prison sentences, substantial ones, will be the rule rather than the exception in significant criminal cases. Swift and certain punishment of financial

crimes is vital to the prosperity of the U.S. and to people’s faith in

the system.

We recommend increasing the available penalties for mail and

wire fraud, the two the statutes that govern most basic forms of

white collar crime. Too often, the public believes that business

criminals receive relatively lenient treatment in court, and unfortunately I think there is some truth to that. Not only are the maximum statutory penalties for fraud and other white collar-type offenses significantly less overall than those for violent offenses or

drug cases, but it appears that judges in some jurisdictions are

sometimes too willing to depart downward from the mandated Federal sentencing guideline range to sentence white collar offenders

to minimal, if any, jail time or home detention, or even probation.

We strongly oppose lenient treatment for white collar criminals.

The bottom line is that white collar criminals are just as much

criminals as those who steal with a gun or a knife. They do real

harm to people, they ruin lives. Jail time performs two functions.

It holds these white collar criminals accountable for their past mis-
169

deeds and it prevents future misbehavior by those executives who

might toy with the idea of beating the system.

Third, the administration’s proposal would provide regulators, investigators, and prosecutors with enhanced investigative tools. As

you know, investigating white collar fraud cases is very challenging

and resource-intensive. Often, the critical evidence is to be found

among e-mails or accounting memoranda of the corporation and its

advisers. Without that documentary or electronic evidence, uncovering the footprints of fraud becomes a virtually impossible task.

Accordingly, the President’s proposal would both simplify and

toughen the law against obstruction of justice, particularly document shredding and destruction. Under the current statute, some

courts have ruled that the Government can only charge someone

for persuading others to engage in obstruction of an anticipated official proceeding. If a person acts alone, no matter how egregiously,

he or she cannot be prosecuted unless a proceeding is actually

begun. The President has asked Congress to clarify this law so that

it unambiguously punishes all individuals who seek to interfere

with law enforcement by removing or destroying evidence.

Although we look forward to being able to use the new tools the

President has proposed, we are proud of this administration’s

record of vigorous enforcement of the laws against white collar

criminals. I am sure the committee understands I am prevented

from discussing pending cases in detail. And, of course, I can’t reveal information about non-public investigations. But I can make

reference to several major corporate investigations which have become public.

WorldCom: The Department of Justice is currently reviewing the

facts behind WorldCom’s recent disclosure that it had improperly

accounted for $3.9 billion in expenses.

Enron: In January, we set up an unprecedented national task

force to investigate the collapse of Enron. The investigation has so

far led to the jury conviction of the accounting firm Arthur Andersen for obstructing justice in connection with an SEC investigation

of its client, Enron. Furthermore, the global managing partner in

charge of the Enron engagement team, David Duncan, has been

convicted by plea of guilty to obstruction of justice in April. He will

be facing sentencing in the near future. More recently, three bankers were recently indicted based on allegations of a multi-milliondollar fraud scheme arising out of one of the Enron-related partnerships. This Enron investigation is active and ongoing.

AllFirst: The United States Attorney in Maryland recently obtained a seven-count indictment against a former AllFirst Bank

currency trader, alleging among other things, bank fraud which resulted in the loss of more than $691 million.

ImClone: The U.S. Attorney in Manhattan is currently investigating allegations of insider trading with regard to ImClone Systems, Inc. You will recall that the former CEO, Samuel Waksal,

was arrested last month and charged with insider trading.

Rite Aid: On June 21, the U.S. Attorney for the Middle District

of Pennsylvania announced criminal charges, including mail and

wire fraud, against five former and current officers of Rite Aid Corporation, the drug chain, including the former CEO. Those charges

involved an accounting scheme that led to a $1.6 billion restate-
170

ment of income. I think at the time it was the largest. It has since

unfortunately been superseded. It has become one of the largest in

U.S. history. One defendant has pled guilty.

In closing, I want to thank you, Mr. Chairman, and the committee for your leadership and the spirit of bipartisan cooperation you

have brought in addressing the challenges of rooting out, punishing, and preventing white collar crime. The President’s proposals in

this area will greatly enhance the Department’s ability to enforce

the laws and ensure that criminals who violate their trust in operating businesses face stiff penalties, including jail time. We look

forward to working with you and the committee as we encourage

a new ethic of corporate responsibility in this country.

Mr. Chairman, that concludes our prepared remarks. I ask that

the full text of my remarks be entered into the record of the hearing, and both Mr. Mercer and I would be happy to answer any

questions the subcommittee has.

Chairman BIDEN. It will be placed in the record, and again I

thank you both for being here. We will do ten-minute rounds.

There are only three of us here at this moment.

Let me begin by saying that one of the things I want to explore

with you, Michael—and I just want you to know I am not picking

on you or anybody, but I think you at the Justice Department

Criminal Division, as well as the FBI, are really strapped. I mean,

you are really in a bind, unrelated to what new laws or any amendments to sentencing we propose or you propose, and that is the administration’s increasingly understandable use of the Justice Department to fight terror, the FBI’s decision understandably to take

518 folks out of the criminal justice area dealing with violent crime

and white collar crime, the fact that since 1993, in the Clinton as

well as in the first year of the Bush administration—in 1993, according to the transactional records access clearinghouse at Syracuse University, the FBI referred 20,893 white collar crime cases.

In the year 2001, the number of referrals was down to 12,000.

That doesn’t mean you don’t still have a heck of a handful here,

but the idea of focusing on white collar crime has been diminishing

for some time. Now, we come along and we tell you you have fewer

resources and more responsibilities. So I am going to be asking you

all back here at some point and telling you you need more money,

you need more staff.

Now, you are going to tell me, because you are a good Republican, and as my friend here will say, you can do more with less

and you just have to order it better. That is so much malarkey, I

am tired of hearing it, and I eventually will convince you that you

need more help because, as Barry Goldwater used to say, in your

heart you know you do. But having said this, you have a real full

plate here.

By the way, I ask unanimous consent that I be able to submit

to the record Mr. John T. Dillon, the Chairman of the Business

Roundtable, his letter to me calling for tougher laws and supporting the Sarbanes legislation.

I might add, Michael, and to my friend, Senator Grassley, one of

the reasons why people in the business community on ‘‘Moneyline,’’

not on ‘‘Geraldo,’’ were criticizing the President yesterday is they
171

fully expected he was going to embrace this and he was at least

going to go as far as the Business Roundtable would go.

It is true he didn’t say he wouldn’t, but there is an old expression, people vote with their feet as to what they like and don’t like.

Well, investors vote with their money. The Dow is down another

167 points today. As the President was speaking, the ticker was

going click, click, click, down 173 points.

The language was tough. For example, he called for increasing

the budget for the SEC by 29 percent. There is bipartisan support

here to do it by 77 percent. He called for making it illegal to shred

documents. We all agree with that, but nothing on insider loans,

nothing on the accounting industry in terms of specifics, nothing on

separating analysts and underwriting in the investment banks. But

I think and I hope that he will support some of the things that we

are proposing.

On the floor as we speak—and I may have to leave to go offer

my amendment—is a bill that many of us have cosponsored, Democrat and Republican. I think Senator Durbin is a cosponsor as

well—correct me if I am wrong, Senator—of the Leahy amendment.

We call for stiffer penalties—and I won’t go through all of that—

including a number of things. I have the White Collar Crime Penalty Enhancement Act of 2002 and I would like to just question you

in my remaining moments on if the Department has a view on it.

This legislation which I am going to amend—well, if I have the

votes, going to amend the Leahy–Biden, et al, and everybody else

who cosponsored it, bill—calls for a couple of things. One, it

amends the general conspiracy provisions of Title 18. Under current law, the maximum penalty, as you know, for general conspiracies to commit a crime against the United States is five years’ imprisonment, while the penalty for the predicate offense for conspiracy is substantially higher.

So what I do in here—and you may not be prepared to respond,

but what I do in this legislation is I make the conspiracy, if it

sticks, the sentence has high as the underlying predicate for the

crime of conspiracy.

The second thing we do is it amends Title 18, Sections 1341 and

1343, to raise maximum penalties for mail fraud and wire fraud

from 5 years to 10 years. Now, as you all know, if you take the

Enron example, assuming that the corporate leadership sent out a

letter to its stockholders saying the stock is going to go up $100,

like they did verbally say that, they would be guilty of mail fraud,

if you could prove it, and it increases that penalty.

The third thing we do is it amends ERISA, the Employment Retirement Security Act of 1974, to increase the criminal penalties.

As I said, right now the maximum, if you, in fact, violate that law,

is a misdemeanor punishable by up to one year. What I do here is

amend it to raise the penalty from 1 to 10 years, leaving the Commission the judgment as to what that would be.

I assume—and Mr. Mercer knows this well—I assume they

would do it based on the law, like you do on theft and like you do

on other things. So if your criminal behavior causes people to lose

$10 million, you are going to go to jail longer than if the pension

loss is $1,000. Also, it directs the Sentencing Commission to review
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and amend the Sentencing Guidelines to provide increased penalties provided under this bill.

Lastly, it creates a new section in Title 18 requiring a certification to be signed by top corporate executives that those financial

reports they are putting out reflect the financial condition of the

company.

Some will say, well, Biden, that is too tough, but there is a fiduciary responsibility that exists. In all cases it requires scienter, and

if they could prove that they were defrauded and they didn’t know,

then they are not guilty. But they have to sign it, and if they sign

it and it turns out it is not accurate, they could receive severe penalties.

Have you had a chance to look at any of those, and if not, will

you?

Mr. CHERTOFF. Mr. Chairman, I received it this morning and I

am very eager to review it. I know from just having scanned it

briefly and from your summary that certain aspects of the proposal

are consistent with what the President said yesterday in his

speech. In particular, the elevation of the penalties for mail and

wire fraud, the directive to the Sentencing Commission to look at

adjusting the Guidelines to take account of the dangers posed by

white collar corporate fraud, and also the certification requirment

are all part of the President’s accountability proposal.

So I certainly look forward to reading this and getting into the

details, and I am sure that we will have comments in short order

from the administration to this proposal.

Chairman BIDEN. Well, that would be useful. Even though I am

going to try to introduce it today and amend it, I say, speaking for

myself only, even if it is adopted today—if the administration looks

at it and if they agree in substance about it, but they have a view

that it should be altered on the margins or a tactical difference, I

am fully prepared to work with you, even though it will have

passed, in conference to determine whether or not it should be altered.

So I mean this sincerely. I am looking for your expertise and this

is not something we shouldn’t be doing together. But as you know,

things have had a way of getting ahead of us here and we are moving along fairly quickly. I hope we don’t move in a way that is

counterproductive, although what Senator Sarbanes has in the bill

has been well thought-out, a lot of hearings, a lot of movement.

I have more questions, but let me yield to my colleague from Illinois and then I will go back to a second round.

Senator DURBIN. Thank you very much, Mr. Chairman. I just

have a few questions.

Mr. Chertoff, I looked through your list of prosecutions. How

many officers of Enron have been indicted by the Department of

Justice?

Mr. CHERTOFF. No officers of Enron to date have been indicted.

Senator DURBIN. None?

Mr. CHERTOFF. Correct.

Senator DURBIN. The decision was made by the Department of

Justice to indict a corporation, Andersen.

Mr. CHERTOFF. Well, it was a decision by the grand jury, actually.
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Senator DURBIN. Certainly, there was some guidance from the

Government.

Mr. CHERTOFF. I would say that it is normally the case that

when matters are presented to the grand jury, it is with the guidance of the Government.

Senator DURBIN. The question I have is when the Government

considered the indictment of the corporation rather than the

wrongdoers, did the Government envision that a successful prosecution would close the corporation and cost 20,000 to 25,000 people their jobs?

Mr. CHERTOFF. Well, let me try to clarify this a little bit, bearing

in my mind, as I know you know, Senator, that I am limited in

what I can discuss about a pending matter.

First, let me dispel a misconception that I think is embedded in

the question. There has actually been a person who has been

charged and convicted, Mr. Duncan. He was convicted of obstruction of justice.

Secondly, the penalty for the single-count indictment in the Andersen case is not going out of business. The penalty is a fine of

$500,000 and possibly probation, and that is the penalty which

Congress has prescribed.

The offense of which this company was convicted is a very serious offense. I can tell you that we can pass all the laws in creation.

If we cannot find the evidence to enforce the laws, because people

destroy it or tamper with it, we are never going to make any cases.

So it is very important at the beginning of a campaign against

white collar crime to lay down a simple proposition: You cannot

play with the evidence, you cannot tamper with the witnesses, and

you cannot destroy the evidence. And if you do those things, no

matter how powerful you are or how much lobbying you do or how

many ads you take out in a newspaper, we will proceed with the

full vigor of the law.

Senator DURBIN. Of course, that is something that we would all

agree with. Any person in any company guilty of that wrongdoing

should be held accountable under the law. I don’t think anyone

would disagree.

The question I asked you was you must have envisioned that a

successful prosecution of Andersen would destroy the credibility of

the company and virtually destroy the jobs and livelihoods of thousands of people who were not guilty of any wrongdoing, didn’t

shred a document, weren’t even close to the scene of the crime.

Mr. CHERTOFF. Senator, let me take you back to something that

the U.S. Supreme Court said 100 years ago, in I think it was the

Standard Oil case, which is one of the first cases that deals with

corporate liability for criminal law—as you know, we have been indicting and prosecuting corporations for at least the last 100 years.

The principle is this: When people band together and form a corporation and they set up a leadership for that company, a management, and they throw their stake in with that, they have to take

the bitter with the sweet. If the company conducts itself properly,

then the profits are rightly distributed among the employees and

the shareholders and everybody else who benefits. But if the leadership of the company allows the company or directs the company

to commit criminal offenses, then the company has to suffer that.
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I think what was envisioned by the Department of Justice in

pursuing this case against the corporation is what was envisioned

in other cases in which corporations have been indicted: that we

would enforce the law vigorously, seek the penalties which Congress has mandated, and that we would not be deterred by arguments that appeal to factors that are extraneous or outside the law,

or by publicity campaigns or by television advertisements or things

of that sort.

Senator DURBIN. I happened to meet about 20,000 of those extraneous factors in Chicago, people who went to work everyday, paid

their taxes, obeyed the law, and were just as upset as you and I

are about the wrongdoing of some people in their company.

Mr. CHERTOFF. Senator, let me——

Senator DURBIN. Excuse me. Most of those people are out of work

today. Those are extraneous factors.

Mr. CHERTOFF. Let me suggest, Senator, that the people who

bear responsibility for the consequences of the criminal offense

committed by the corporation or the partnership are those who led

it and those who had the responsibility to make sure that the law

was followed.

When you have a senior partner in a company convicted of committing a criminal offense and when you have evidence at trial that

indicates the involvement of others, I think the law has to operate

in the way that Congress intended it.

Senator DURBIN. To indict the corporation.

There is an old saw that the law in its infinite wisdom makes

it a crime for both the rich man and the poor man to sleep under

the bridge. I would like to ask you on the issue of mandatory minimum sentences—we have made it clear in Congress, with the support of this administration, that we are going to establish mandatory minimum sentences for the sale of small amounts of narcotics,

a thimble full of cocaine.

Do you believe that when we are talking about wrongdoing by

corporate officers, whether it is the destruction of documents, misleading the public, defrauding the public, that we should establish

mandatory minimum sentences as well?

Mr. CHERTOFF. I think what the President has said is that in formulating the Sentencing Guidelines which direct the judges as to

how to sentence that the Sentencing Commission ought to impose

as sentencing guidelines that would require jail time very serious

penalties for corporate officials who violate their public trust.

Senator DURBIN. Mandatory minimum sentences?

Mr. CHERTOFF. Well, I think the way the Guidelines operate, if

one is observing the rules about departures, federal sentencing is,

in effect, mandatory: the required sentences for people who commit

serious white collar offenses, unless very narrowly tailored downward departures are appropriate would be prison time. I think if

we have that kind of a regime which the President has called for,

we will have, in effect, required jail time for big corporate criminals.

Senator DURBIN. Do you feel that Congress was mistaken in 1995

when it changed the securities legislation so that the law no longer

allowed suits to be brought by individuals against corporations for
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securities fraud? Some have suggested this has helped to create the

climate that has led to this corporate corruption today?

Mr. CHERTOFF. Well, I have to say, Senator, first of all that my

area of expertise and responsibility does not extend to private civil

lawsuits against corporations for securities fraud. I am not sure

that I would say that they prevented those lawsuits.

What I would say, though, is I think our focus, certainly the

focus of the Department, is on enforcement of the criminal law. Obviously, the SEC has its own powers, regulatory powers and civil

enforcement powers, which it then deploys. So I have to, I guess,

suggest that the issue of private lawsuits is one that really goes

outside of my area of expertise and jurisdiction.

Senator DURBIN. Well, I would just like to suggest to the committee I think it had a lot to do with it. Those people at Enron who

are now being sued are using as a defense that they could not be

found guilty of aiding and abetting because of the congressional action on security litigation reform. We are going to consider that

issue in the bill that is presently before Congress. I just sincerely

hope that when this is over that we will look back and say that

the wrongdoers will pay a price.

Do you have any idea when the first person at Enron may be indicted for wrongdoing?

Mr. CHERTOFF. Again, as I think you know, Senator, it would be

a violation of any number of rules and laws for me to start to predict who might be indicted or when they might be indicted.

What I can tell you is we have a dedicated, large group of prosecutors and agents who are making this investigation their fulltime business, and there is a very deep and profound determination on the part of the Department, including on my part personally, to see to it that anybody who has violated the law is going

to be punished, whether it be in the case of Enron or any other

white collar offender.

Senator DURBIN. Well, I just think it is odd that a shoplifting actress in Hollywood is facing more time in jail than any officer in

Enron as we speak today, and I hope that that changes in the near

future.

Thank you, Mr. Chairman.

Chairman BIDEN. Thank you.

I would ask unanimous consent that a statement that I made in

1995 on the so-called Private Securities Litigation Reform Act be

put in the record at this point. There being no objection, it is so

ordered.

I agree with the Senator from Illinois. I think it has a gigantic

influence. If I am not mistaken, there were only about eight of us

who voted against that at that time.

Senator DURBIN. And 99 in the House.

Chairman BIDEN. And 99 in the House.

Part of what I am about to introduce as an amendment on the

floor is to undo three pieces of the seven major changes we made

in that law. It is out of the jurisdiction of our friend from the

Criminal Division, but I can assure you we will hear more about

it.

The Senator and former U.S. Attorney and a man who, were I

white collar criminal, I would not want to have gone before, having
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worked with him for these years, the Senator from Alabama, Senator Sessions.

STATEMENT OF HON. JEFF SESSIONS, A U.S. SENATOR FROM

THE STATE OF ALABAMA

Senator SESSIONS. Thank you, Mr. Chairman. I fundamentally

agree with the purpose of your hearings, as I understand it, and

that is we have too light sentences for serious white collar crime.

I know Mr. Chertoff remembers the arguments 8, 10, 15 years

ago. It was we have got too many people in jail; jails need to be

reserved for dangerous criminals, not for non-violent white collar

criminals. We heard those arguments.

But in the course of that I think we went too far, because when

a person defrauds thousands of people, many of them losing their

life’s savings, deliberately and with clear criminal intent, then that

is a serious crime.

Harsh sentencing does deter. I was a United States Attorney

during the Savings and Loan fraud cases. I prosecuted Federal

land bank fraud cases. My office prosecuted those cases that I supervised, and I am going to tell you there is a lot better behavior

in banking today because people went to jail over those cases in the

past. They lost everything they had, their families were embarrassed, and a lot of people started checking to make sure they were

doing their banking correctly.

So I kind of have a sense that it is deja vu all over again, as Yogi

says. The CEOs of America somehow felt nobody was watching. We

have gone through a period of unprecedented growth.

The way these banks got in trouble, Mr. Chairman, if you will

remember, is nobody found them to be cheating and defrauding

until the price of real estate collapsed. While it was going up, it

never revealed itself. It is sort of what is happening in the corporations today. While everything was going so great these problems

could be covered up, and now they are coming home to roost.

I do believe in the justice system, which means that every person

is presumed innocent and he is entitled to his day in court, but I

do hope you are working on your team to move forward rapidly.

Let me just ask you, Mr. Chertoff, in your role as a prosecutor,

as a Former United States Attorney, you have seen some of these

bank fraud cases. Do you see a similarity between the misbehavior

now of corporate America as compared to what we were seeing in

the late 1970s and early 1980s with the Savings and Loan community?

Mr. CHERTOFF. There is a similarity, Senator, because we went

through a wave back, I guess, 10 or 15 years ago where there were

a minority, but nevertheless a troubling minority of bank officials

who were violating the law. And I completely agree with you. I

think the aggressive use of law enforcement made a real difference

in terms of cleaning up banking and savings and loan activity.

I think we are facing a similar situation here. There is a minority, but still a troubling minority of people who are abusing and

violating the rules in order to achieve a short-term economic gain

for themselves and their companies. I think by having swift and

tough penalties, we are going to change the way these corporate officials think and operate.
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Senator SESSIONS. To follow up on that precise point, it seems to

me that many have argued that white collar criminals are deterred

just by the bankruptcies, by the short time in jail, and all of those

things. But to me, there is a moral question here. If a person embezzles $50 million, or maybe more, as some of these cases might

suggest, their sentencing range should not be a lot different than

somebody who robs a bank, in my view, if it is intentional fraud.

So I guess my question is are you in accord that we need to enhance the penalties on these kinds of cases?

Mr. CHERTOFF. I don’t think there is any doubt we do. The

amount of destruction that is caused by a person who commits a

white collar crime, like a fraud, can be every bit as serious as the

destruction caused by a burglar or somebody who commits what we

would normally consider not to be a white collar crime.

That is one of the reasons I think the President has called for

not only an enhancement of the penalties according to the statute,

but also for the Sentencing Commission to make sure that we are

adequately aggravating sentences to take account of those who betray their corporate trust.

Senator SESSIONS. The way the Sentencing Guidelines are focused, I believe, is a bit off center. Their focus is on the extent of

the loss, or in a drug crime almost exclusively on the amount of

the drugs, the weight of the drugs. But I have always felt that the

true measure of criminality and the punishment is the degree of

criminality, the degree of malicious intent, the degree of conscious

fraud that has occurred.

Do you think we can do a better job of considering that factor in

the sentence that is imposed?

Mr. CHERTOFF. Well, the Guidelines do contemplate that one can

look to factors other than just the amount of the loss or the amount

of——

Senator SESSIONS. It is fairly limited.

Mr. CHERTOFF. There is no question the Commission could consider the possibility of adding more weight to other factors, such

as the degree of violation of trust, irrespective of the dollar loss. So

I think there is a wide range of choices that can be made by the

Commission in terms of how to implement a broader vision of what

kind of penalties are appropriate in white collar cases.

Mr. MERCER. I would like to add something to the Assistant Attorney General’s comments on that. I think one of the things that

we really face as U.S. Attorneys in trying to deal with this is the

fact that we have an increasing number of non-substantial assistance downward departures.

Senator SESSIONS. By the court?

Mr. MERCER. By the court, upon a defendant’s motion. In a white

collar case——

Senator SESSIONS. Do you consider those rulings in violation of

the Guidelines?

Mr. MERCER. The courts clearly have authority to do so either as

factors that are considered and have been specifically incorporated

within the Guidelines by the Commission and/or by the Supreme

Court’s decision in 1996, in Koon, where the Court said if a factor

wasn’t specifically prohibited, then a court can consider that in

terms of crafting a sentence.
178

So it is rare for white collar sentencing to occur without a defense lawyer saying there are extraordinary circumstances based

upon the community ties or the community service that the defendant rendered prior to sentencing. Or maybe there has been extraordinary post-offense rehabilitation, or maybe there are family ties or

circumstances.

We hear about these all the time when we are sentencing criminal cases, and I think it really goes to Senator Durbin’s question.

If you have a range that the Commission has established that, in

their view, appropriately deals with a crime for courts then to enter

downward departures—and we had 600 non-substantial assistance

downward departures in the fraud guideline in 2000 is troubling.

There are a substantial number of districts that have substantial

numbers of non-substantial assistance downward departures in

fraud cases.

Senator SESSIONS. Were those on the recommendation of the

prosecutor or all on the judge’s own decision?

Mr. MERCER. Well, that is based upon the judge’s authority. It

is not a substantial assistance departure where——

Senator SESSIONS. No, but you could still agree to it. Do you

know if those have been over the objection of the prosecutor, or do

your numbers disclose that?

Mr. MERCER. The data set that I am looking at doesn’t disclose

that. I can tell you that in U.S. Attorney Comey’s testimony before

this committee, in his prepared remarks, we summarized a number

of court decisions where the Government had taken affirmative appeals to object to non-substantial assistance downward departures

made by courts.

I think the committee can get a flavor of the Government’s concern in those cases. But as we said in that testimony, there are a

number of times based upon the Koon decision or based upon

where a factor isn’t prohibited that we simply aren’t really able to

pursue an appeal because it wouldn’t be one that would be reversed

by the court of appeals.

Senator SESSIONS. I remember, Mr. Chairman, when I first became United States Attorney before the Guidelines were passed,

which was the most significant change in the history of law enforcement since the founding of this country.

Chairman BIDEN. Thank you very much.

Senator SESSIONS. And you deserve much credit for that. I remember telling a Federal judge, in exasperation, when a defendant

had smuggled 15,000 pounds of marijuana, and the Judge was

thinking about giving a 5-year sentence, I said, ‘‘Sir, we just had

a presidential election. The President of the United States put me

here and the American people have spoken on this.’’ But the judge

could give zero to 15 years, totally unlimited, whatever he wanted

to do.

I think the judges began to sense from the American people that

the judges cared more deeply about large drug smugglers and sentences went up, and then the guidelines kept them up. And I believe we are at this point now.

Chairman BIDEN. I agree.

Senator SESSIONS. I think it is perfectly appropriate for Congress

to affirm that we need to do a better job of that.
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My time is up. Mr. Chertoff, I know you can use some additional

prosecutors, but there are a whole bunch of them out there from

the Savings and Loan days. I don’t know what they are doing. I

don’t know how many more new ones you need, actually. It is just

an emphasis. If it is clear that you expect your team to give it high

priority, I think you may have enough people already, or close to

it.

Chairman BIDEN. Thank you very much.

As we break for this vote, because we only have a few minutes

left, I would just like to point out the losses weren’t just the people

at WorldCom who had pensions. It cost the State of California retirement system over half a billion dollars; $300 million, the State

of New York pension fund; Michigan pension fund, $116 million;

Florida, between $85 and $100 million; Kentucky, $8 million; Wisconsin, $36.3 million; Iowa, $33 million.

Senator SESSIONS. Alabama took a hit, too.

Chairman BIDEN. I assume my staff just picked the biggest ones.

Do either of my colleagues have more questions for this panel?

I do, but I am not going to ask you to wait because we are going

to be about 15 minutes, my guess is, and there may be another

vote immediately after this. So what we will do is I am going to

submit about six questions in writing for you, if I could, General.

I would suggest to the next panel that if you have time, you can

go down and get a cup of coffee. I apologize. We don’t control the

floor and it is going to take us somewhere between 10 and 25 minutes, depending on whether there is a second vote, to get back

here.

I thank the Justice Department for its cooperation and look forward to your input specifically on the legislation, and I also look

forward to the questions you have.

[The prepared statement of Mr. Chertoff and Mr. Mercer appears

as a submission for the record.]

Chairman BIDEN. We will now recess until the call of the Chair,

which I expect to be about 15 to 20 minutes.

[The subcommittee stood in recess from 3:31 p.m. to 5:29 p.m.]

Chairman BIDEN. The hearing will come back to order, please.

We owe this incredible panel that we are so looking forward to

hearing a sincere apology and a debt of gratitude for waiting. This

is above and beyond the call.

You guys remember when you were in school the old joke was

you only had to wait 20 minutes for a full professor. You only have

to wait two minutes for a Senator, and you guys have exceeded

that by a couple of hours. Senator Sessions and I were tied up. The

irony of all ironies—and I won’t take much more time explaining—

is that the very thing that we are talking about on this panel literally got called up on the floor of the Senate as we were waiting

here. So I am truly sorry.

The next panel that we have, and our last panel, has some very

distinguished members. John Coffee is Professor of Law at Columbia Law School, one of the great law schools in the country. Before

going to Columbia, Professor Coffee was a lawyer at Cravath,

Swain and Moore, where my more successful colleagues at Syracuse went to work. He was a reporter for the American Law Institute’s Principles of Corporate Governance. Professor Coffee is an
180

expert on corporations, security regulation, and white collar crime,

and has published numerous books and articles on these topics. We

thank him for being here today.

Second, we have Thomas Donaldson. He is Professor of Legal

Studies at the Wharton School at the University of Pennsylvania.

He was previously Professor of Business Ethics at Georgetown University. He attended school at the University of Kansas, where he

majored in business, and got his Ph.D. in philosophy also from the

University of Kansas. The professor has written four books on business ethics and more than 70 academic articles and book chapters.

I welcome him as well.

Charles Elson is Professor of Corporate Governance and Director

of the Center for Corporate Governance at the University of Delaware. Before that, he was Professor of Law at Stetson University,

a university my colleague and I know well, and an attorney at Sullivan and Cromwell.

Professor Elson is an expert on corporations, security regulation,

and corporate governance. He has written on these issues extensively and is the Vice President of the American Bar Association’s

Business Law Section Center on Corporate Governance. I want to

thank him for making the trip down, and maybe we will be on the

same trip home. Columbia and Penn, where my son went to school,

are good, but Delaware is better. That is my alma mater.

George Terwilliger is a partner at the law firm of White and

Case, where he leads their corporate defense and special litigation

group. Before that, he served as a Federal prosecutor for over 10

years, and later as the Deputy Attorney General in the first Bush

administration. Mr. Terwilliger earned his B.A. from Seton Hall

University and his J.D. from the Antioch School of Law. I want to

thank him for coming as well.

Tom Devine is the Legal Director of the Government Accountability Project, a non-partisan, non-profit interest group that works

to protect the rights of whistleblowers. Mr. Devine has been working at the Government Accountability Project for more than 20

years and has been a resource for this committee on more than one

occasion. He has also taught and written about whistleblower protection issues. Mr. Devine is a graduate of Georgetown University

and Antioch Law School, and I want to thank him as well for joining us.

Gentlemen, I will not take any further time, and unless you all

have worked out something different, if you could deliver your testimony in the order in which you were called. Usually, we have a

rule on time. There is no rule. You all take as much time as you

want. Again, I thank you very, very much for waiting for me.

STATEMENT OF JOHN C. COFFEE, JR., ADOLF A. BERLE PROFESSOR OF LAW, COLUMBIA UNIVERSITY SCHOOL OF LAW,

NEW YORK, NEW YORK

Mr. COFFEE. Senator, thank you for having me here, and let me

start out with the statement that I really have two areas of specialization—securities law and corporate governance, on one hand,

and white collar crime and sentencing on the other. For the last

year, these two fields have merged.
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Now, we are talking about a series of scandals and issues that

have broad macroeconomic impact. Absolutely every topic is relevant, but I am going to be very narrow. I am going to talk about

the criminal law because I am someone who teaches the criminal

law regularly and I want to explore with you the various levers

that I think could be better used to maximize deterrence in the

area of white collar crime.

My initial message has already been stolen by Senator Sessions,

because he said he had some problems earlier with the way in

which the Sentencing Guidelines manual looks at fraud, embezzlement, and similar types of offenses. I think that particular guideline is a little out of date. It has got at its core a kind of a concept

that says securities fraud—we know what that is; that is the Ponzi

scheme in which the promoter sells stock to the investors, and we

will just look at the amount of sales he made to those investors.

That is not what is going on in an Enron or WorldCom or anything like that. We are dealing with cases in which the books have

been cooked. There are serious accounting irregularities and the

loss is not simply the loss to the individual investors, because

frankly the company may be selling no stock during this period.

The loss is really the broader social loss of investor confidence in

the system being eroded.

When that happens, it is not just that stocks everywhere decline,

not only at Enron but a perfectly legitimate company like General

Electric will have a transparency discount, but the broader loss is

that when investor skepticism grows and they lose confidence in

the reported financial numbers, the cost of capital for American

corporations rises. And when the cost of capital rises, that means

interest rates go up, economic growth is retarded, and layoffs become inevitable.

In that light, I think we should recognize that senior corporate

management involved in and convicted of securities fraud, particularly securities fraud involving the credibility of financial statements, is creating a social loss far greater than the loss borne by

individual investors, however computed.

Now, having said all that, I wrote this before I saw today’s Biden

bill, which does instruct the Sentencing Commission to develop a

new guideline, and I would certainly endorse that. I read the Leahy

bill, but I had not read your amendment to it, and I think that is

something that should be done.

I think that it should focus on criteria such as was there an earnings statement, how many quarters were affected by this, what

level of management was affected, et cetera. I think there should

be an express recognition that when there is a person with a very

high-ranking fiduciary duty—the chief executive officer—it is a

more serious offense by that person than by someone two levels

down the totem pole who may be under pressure from the top.

All of that, though, is something I think the Sentencing Commission can address. I once served as the American Bar Association’s

reporter on sentencing alternatives.

Chairman BIDEN. I remember that.

Mr. COFFEE. I would urge you to go the Sentencing Commission

guideline route rather than adopting mandatory minimums. There

is always some over-breadth in mandatory minimums.
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Now, what else can be done under the Sentencing Guideline

route? We have heard a great deal of interest expressed, including

by the President yesterday, in recapturing, let’s call it the unjust

profits that a chief executive receives when he got stock options,

bonus compensation, during a period in which the company’s stock

price was inflated. The board of directors may have believed that

he was doing a great job. Only later do you learn that all those

numbers were fabricated.

There is a concept in sentencing that I think needs to be given

greater attention. It is not just the area of fines, it is the area of

forfeiture and disgorgement. American sentencing law says that if

you catch a person with ill-gotten gains, he forfeits that. In other

words, if I am a bank robber and I am caught robbing a bank with

$1 million in my hand, I am not fined $1 million. I just forfeit it

because it wasn’t properly mine.

I think when we look at the area of executives who have received

stock options or seen those stock options inflate during the period

in which corporate financial statements were seriously and materially false, it is possible to deem that a form of unjust ill-gotten gain

that could be captured underneath the disgorgement sanction.

Now, I am not saying that Congress should say this itself. I

think the Congress should rather instruct the Sentencing Commission to develop the concept of forfeiture and disgorgement, as it

might be used as an additional sentencing sanction, in addition to

criminal sentences and fines, as a way of having one expedited proceeding in which they would forfeit, if convicted of a crime, the illgotten gains, which could include bonus compensation, stock option

appreciation, or the award of stock options.

Again, there is a need for detailed and nuanced guidelines, but

I think that is an additional area which we would have one proceeding that would efficiently take away all the gain, rather than

talking about having the SEC or a private plaintiff sue them.

Chairman BIDEN. Professor, can I ask for a clarification on that?

Mr. COFFEE. Certainly.

Chairman BIDEN. I am the guy that drafted the forfeiture legislation relating to drug cases. So when we use the word ‘‘forfeiture’’—

I understand it in a literal sense, but it is used up here and anyone

reading your testimony will assume that we mean that if you can

prove that the ill-gotten gains were $5 million and you could not

find the cash, you can go take his house. You can take his car, you

can take his yacht, et cetera.

Is that what you mean when you use the word ‘‘forfeiture?’’

Mr. COFFEE. That is one way of doing it. It is also possible to use

simply the common law approach which the Guidelines could codify

that if you had the proceeds of a crime in front of you in a court,

that gets automatically forfeited.

Chairman BIDEN. But if you don’t have the proceeds of the crime

in front of you in court—in other words, he has cashed out the

stock options.

Mr. COFFEE. Money is fungible. I think you could trace the

money.

Chairman BIDEN. Yes, okay. I just want to make sure we are

talking about the same principle.
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Mr. COFFEE. Well, I think you give some authority saying we

want to have the concept of forfeiture apply to these ill-gotten

gains, and instruct the Commission to come up with a more——

Chairman BIDEN. As opposed to drafting legislation?

Mr. COFFEE. As opposed to simply either writing a one-sentence

statute that won’t deal with all the problems, or as opposed to instead telling the SEC to sue or telling private plaintiffs that they

can sue, all of which will take five more years and involve two or

three more judges.

Chairman BIDEN. I am with you. I just wanted to make sure I

understood it. Thank you very much.

Mr. COFFEE. Now, additional things I think you should focus on:

There will also be occasions in which the corporation will be prosecuted. That may or may not happen in Enron because it is bankrupt, but securities fraud is an offense——

Chairman BIDEN. It happened at Andersen.

Mr. COFFEE. Okay. It certainly is a case in which we would like

to see corporations occasionally prosecuted. I won’t get into the nuances of when yes and when no. When we do that—and I was one

of the draftsmen of these provisions back in 1991—we have very

elaborate organizational guidelines which put very significant

weight on whether or not the corporation has an effective compliance plan.

There are seven elaborate criteria set forth in the Sentencing

Guidelines manual to determine when you do have an effective

guideline compliance plan which can reduce the sentence by 50 percent or more. We have had those guidelines for a decade now and

I don’t think anyone has a clear idea of whether or not those guidelines have any deterrent value, whether they are producing compliance plans that do reduce the risk of corporate crime, that do create greater internal monitoring.

I think there is some possibility that those compliance plans

were all adopted by one or two law firms coming up with a standard form compliance plan that is used by 500 corporations, with

very little attention.

I think two things. There should be a study about whether those

compliance plans do create enough value to justify the enormous

sentencing credit that they create. There is lots of theory here, but

very little observation.

Secondly, I think we can easily redesign these guideline compliance plans so as to create a number of desirable consequences, including much greater protection for whistleblowers. I certainly understand that the Leahy bill gives protection to whistleblowers

against retaliation, but that comes when we are talking about the

criminal law at the later stages.

If a company wants to have an effective compliance plan, it

would be possible to address in it and require as a minimum condition that these compliance plans had to establish a variety of techniques, whether they are anonymous hotlines, whether they are direct connections to the audit committee.

I don’t want to get into the details of specifying what should be

the adequate procedures to invite anonymous and confidential comments from employees who feel that this conduct is occurring, and
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I don’t want to get into the details of who they should report to,

whether it goes to the audit committee directly or someone else.

But I think we can take best practices as they now exist and incorporate them into our standard of what a compliance plan should

look like, because a compliance plan is ultimately an invitation to

the company to do something in advance to get an enormous credit

in the event that you are ever convicted. I think that is an area

where you can take best practices, not make them mandatory, but

say if you want enormous sentencing credit, you should be complying with the best practices in the area of both compliance plans

and treatment of the potential whistleblower.

A last point, because I realize I am running long on time. We

have another sanction that is available but little used. It is corporate probation. Now, it can be used in addition to a sentence

when we convict the corporation. When we have that kind of world

in which the corporation appears to have been somewhat dysfunctional and there were corporate governance failures, we will often

find that there are corporate officers, past or present, who may

have deceived the company, received ill-gotten gains, elaborate

loans in some recent examples, and we have a problem.

The corporation may have great difficulty asserting claims

against those individuals because the corporation has its own internal conflicts. There may be a controlling shareholder, there may be

other problems on the board of directors.

One way to resolve that is to authorize as a condition of probation that the court appoint a court-appointed monitor, which monitor would have the corporation’s power to assert claims against

past and present officers and directors who may have engaged in

improper self-dealing.

What I am suggesting is that as part of the sentencing process,

the court could appoint a basic equivalent to the special counsel

that we all know about from the public sector. The public sector

has special counsels occasionally investigating Cabinet members

and the like. If we have pathology in a corporation and the corporation has been convicted of a crime and there is some evidence that

individuals may have wronged the corporation, appointing such a

court-appointed monitor, with authority in the name of the corporation to sue for a recovery to the corporation, creates an efficient

and fairer and more independent procedure than either relying on

a board of directors that might be compromised in some cases or

relying on the tender mercies of the plaintiff’s bar, which often gets

a larger fee than they get a recovery in the world of derivative actions.

So I suggest there are ways that the concept of corporate probation could be utilized to try to rectify corporate governance problems that emerge in these corporate accounting irregularity cases,

and in particular that they can be used as a way to ensure that

individuals don’t escape with their unjust gains.

Thank you.

[The prepared statement of Mr. Coffee appears as a submission

for the record.]

Chairman BIDEN. Thank you very much, Professor.

Professor Donaldson, thank you for being here today.
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STATEMENT OF THOMAS DONALDSON, MARK O. WINKELMAN

PROFESSOR, THE WHARTON SCHOOL, UNIVERSITY OF PENNSYLVANIA, PHILADELPHIA, PENNSYLVANIA

Mr. DONALDSON. I speak not as an expert in law, but in business

ethics, and I am reminded of the fact that over 200 years ago Adam

Smith, the father of capitalist, himself a professor of ethical philosophy, said something that agrees well with what Amartya Sen, the

recent Nobel Prize Winner in Economics, said, namely this remarkable system of capitalism—even this remarkable system doesn’t

function well unless it can rely on the integrity of its participants.

There are a number of economic duties of citizenship that are required in order for capitalism to function well. Some of these are

engaging in fair competition, not abusing government relationships,

providing non-deceptive information to the market. Recent scandals

have turned heavily on this last issue. When companies fail to provide investors with accurate information, investors make worse decisions, and in turn efficiency lowers.

However, one characteristic winds its way throughout all of these

duties of economic citizenship, and it is that for markets to function

well, at least a critical mass of people, and in particular executives

and managers, must behave much of the time for reasons that assign intrinsic worth to certain values; that is to say, we have to

have a threshold mass of people who are willing to do something

because it is the right thing to do and not because they will avoid

legal penalties, and not even because they will avoid financial

losses.

The limits of the law and regulation to cope with corporate ethics

became obvious in the last century as we learned, for example, that

information inside an industry often races ahead of the knowledge

outside of it, including the knowledge of regulators. Industries like

asbestos became very difficult for regulators and the government to

regulate effectively because knowledge inside the industry typically

led knowledge outside the industry. In recent scandals, it was often

a new, clever scheme, a financial arrangement such as the raptors

at Enron that bedazzled and cheated investors. By the time the law

and the investor had caught up, it was too late.

None of this is to say that we don’t need new and tougher laws.

In fact, we do, and I support very much what I have seen coming

out of this committee and indeed what is being proposed today in

the Senate, but it is to clarify the contours of a broad solution to

our current mess.

Unfortunately, many of the most popular attempts to improve

corporate ethics have been either lukewarm successes or failures.

My colleague, Professor Coffee, alluded to one of them, namely the

compliance systems that have arisen in the wake of the corporate

criminal sentencing guidelines.

Ethics and compliance programs abound now; they are hot. In

1991, I don’t have to tell you the U.S. Sentencing Guidelines offered companies a dramatic incentive to develop formal programs.

The Guidelines promised reduced penalties in exchange for bona

fide ethics and compliance programs.

Unfortunately, no persuasive data exists suggesting a correlation

between having such a compliance program or an ethics code and

lessened pressure on executives to commit unethical acts. In fact,
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some of what was being suggested here has already been attempted.

My colleague, Bill Laufer, at Wharton has done a study of the

efficacy of the corporate criminal sentencing guidelines and the results have not been encouraging. Now, I don’t think this is because

codes and compliance——

Chairman BIDEN. Has that study been done and published?

Mr. DONALDSON. Yes, Bill’s study has been published and I will

be happy to make it available to you.

Chairman BIDEN. Great. I would like to see it. I am just unaware

of it and I would like to see it.

Mr. DONALDSON. By the way, let me hasten to add I am not suggesting that codes and compliance programs are worthless. In fact,

I think, when well designed, they are very important. That is not

my point. In fact, discovering whether they are effective or not, I

think, is an almost insurmountable technical research task.

But one thing is clear from this. Codes and compliance programs

are, at best, only the first steps in successfully managing corporate

ethics. We would do well to remember the dazzling creativity of

corporate slime. In the recent spate of Enron and WorldCom tragedies, every time it has been a new scam.

Enron, for example, had all the bells and whistles of a modern

compliance program. Employees had wallet cards. Almost all of

them could repeat the word, RICE, Respect, Integrity, Communication, Excellence. And they had the usual thick list of rules that was

passed around and signed every year. None of this came close to

preventing the Enron implosion, nor are such mechanisms relevant

for virtually any of the recent scandals.

The most important determinants of ethical behavior in a corporation are the way managers are rewarded, the culture of the

corporation, the leadership example that is set, and the institutional systems surrounding the corporation, including legal and

regulatory systems.

Hence, it is a mistake to think that our current problems are

simply the product of a few bad apples. Corporate Watergates typically involve scores, and sometimes hundreds of people inside the

corporation, and often many people outside the corporation in institutions such as accounting firms, investment banks, and law firms.

I believe the single most important change fueling the recent corporate scandals is the transformation of the compensation system

for upper-level executives. We have moved from a cash-based system to a stock-based one. Good reasons exist for the change, but

we must now see that the game of executive motivation has forever

changed.

Over the past two decades, I have talked with hundreds of executives about issues they have confronted in ethics behind closed

doors. During the last six years, the tone of those conversations has

shifted markedly. Increasingly, short-term stock price has assumed

significance as the salient goal, and increasingly these executives’

ethical pressures center on either the demands they must make or

the demands they must fulfill to bolster short-term stock price.

That is one of the reasons I very much agree with Senator Biden’s

suggestion that we need to get at the incentive system that surrounds executives in the corporate suite.
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What should we do? We need more laws of the kind that are

being considered today. We need better enforcement and more resources, and we need to arrange the incentives in the executive

suite. But we also need to educate Americans, and especially current and future executives, about the importance of ethics.

Part of this duty falls on you, elected representatives, but a lot

of it falls on me and my colleagues, especially at business schools.

These schools, the training grounds for tomorrow’s executives, have

the unavoidable duty of taking ethics seriously wherever it arises,

in accounting, in marketing, in management, and in finance.

Thank you.

[The prepared statement of Mr. Donaldson appears as a submission for the record.]

Chairman BIDEN. Thank you very much, Professor.

Professor Elson?

STATEMENT OF CHARLES M. ELSON, EDGAR S. WOOLARD, JR.

PROFESSOR OF CORPORATE GOVERNANCE, AND DIRECTOR,

CENTER FOR CORPORATE GOVERNANCE, UNIVERSITY OF

DELAWARE, NEWARK, DELAWARE

Mr. ELSON. I come to you all as a professor of corporate governance, but I used to be a law professor in my old life, so a little law

will leach its way into my testimony.

Chairman BIDEN. That is okay.

Mr. ELSON. Good for the soul.

When I taught law, the fundamental point to law students visa-vis civil and criminal sanctions was that criminal sanctions were

designed to punish and deter. That was the whole point. White collar criminal prosecution has the exact same goal, to punish wrongdoers and deter bad conduct going forward. How does this apply in

the corporate context?

I believe very strongly in criminal prosecution and punishment

for those who intentionally act in a self-enriching fraudulent manner, in violation of the securities and other financial regulatory

law. I think it is good deterrent policy. Criminally prosecuting folks

who break the law intentionally deters bad conduct going forward.

I think an example of this is in the area of insider trading regulation. Initially, insider trading was prosecuted civilly. It didn’t

work, and by the mid–1980s we engaged in a number of criminal

insider trading prosecutions, very high-profile, and I think they

achieved the proper deterrent impact.

Obviously, in the corporate fraud area the same thing applies. I

think that the solution is to enforce the laws on the books and commit more funds to enforcement. It is good deterrence. If someone

aggressively, actively, knowingly violates the law, they should be

punished.

Now, I think it is important to create a distinction, though. It is

fine to punish self-dealing, or, in the vernacular, sleazy conduct

and those who conduct that sleazy conduct criminally, perfectly

okay. The problem, though, is when you begin to change the standard a little bit and prosecute what is, in essence, slothy or sloppy

conduct in the corporate context criminally.

I think what then happens, unfortunately, is it creates the wrong

incentives, in that it will result—and this comes out of what was
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referred to earlier, the Federal sentencing guideline corporate compliance code, or as we say in the State law context the Caremark

codes, which results, I think, in numerous procedures that are

adopted by companies to prevent legal liability that end up elevating form over substance, and in the end I think create activity that

is harmful to shareholder interests because people are more interested in meeting the legal requirements than actually thinking

through what was the intent of those legal requirements—form

over substance, if you will.

I think when you prosecute someone criminally for slothy or sloppy conduct, it creates a desire on the part of those slothy individuals to avoid potential liability and it creates systems within the

corporate organization that, in fact, are form over substance. I

think that is what happened, unfortunately, in the Sentencing

Guidelines and the Caremark case.

The solution to slothy conduct is internal. It is creating vigilant,

independent, equity-compensated, equity-holding boards of directors. I think that that in the end creates the greatest incentive

within the organization to act carefully.

On the other hand, self-dealing conduct can’t be dealt with in

that manner and it has got to be dealt with through the criminal

process, because I think as we saw in the insider trading area, it

was the only effective method, in my view, of deterring future bad

conduct.

Chairman BIDEN. Thank you very much, Professor.

Mr. Terwilliger?

STATEMENT OF GEORGE J. TERWILLIGER, III, WHITE AND

CASE, LLP, WASHINGTON, D.C.

Mr. TERWILLIGER. Thank you, Mr. Chairman, Senator Sessions.

As you noted, I was a Federal prosecutor for 15 years. Today, I am

in private practice at an international firm and I regularly represent corporations and other institutions involved in Government

investigations, enforcement proceedings, and sometimes prosecutions.

Senator SESSIONS. Do you think he has gone soft now that he has

been representing those big corporations?

Chairman BIDEN. No, no.

Senator SESSIONS. Maybe we will get an objective analysis, having been on both sides.

Mr. TERWILLIGER. I hope so, Senator.

I do have the privilege of helping clients today understand and

navigate the business enforcement issues, but I also cherished my

role as an Assistant U.S. Attorney, as a colleague of yours, Senator

Sessions, as a United States Attorney, and as Deputy Attorney

General.

I vigorously prosecuted white collar crime cases, including the

BCCI matter which involved the prosecution of a corporation.

While I was U.S. Attorney in Vermont, I tried a case against two

local bank presidents, one of whom was very popular. They abused

positions of trust and went to jail.

I accepted your kind invitation to be here today and stuck

around, Senator Biden, because——

Chairman BIDEN. I do appreciate it, I really do.
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Mr. TERWILLIGER. Well, I am happy to be here because I believe

it is essential that this loss of faith that we are talking about in

business be remedied, but I also fear that we are in danger of overreacting in how we respond.

The crisis we have is to one of the most fundamental prerequisites to our economic well-being—investor confidence in the

capital markets. Without that kind of confidence, our economic engine is starved for fuel. But because the matter of confidence in financial reporting is so fundamental and sensitive, steps taken to

address it, in my judgment, should be carefully considered and

measured.

Most business leaders today are, in fact, honest, law-abiding, and

faithful to their duties to secure the interests of stockholders. Many

may indeed be aggressive, and in most cases rightly so. A few are

crooks. Now, however, the many bear the burdens created by those

few.

Financial accounting and reporting is not an exact science. Experts can, and do, disagree about how accounting items should be

treated. These disagreements and uncertainties, though, are different than the intentional exploitation of fuzzy lines to perpetrate

a fraud.

In the context of financial reporting, a fraud means that investors and regulators are intentionally deceived about a company’s

performance, not simply that experts disagree about how that performance should be accounted for and reported.

Truly corrupt business practices, of course, deserve sanctions, but

I believe we need to be very careful about whom, and more importantly what we sanction. Corporations and other business entities

provide the jobs that give Americans an unparalleled standard of

living and fuel the crucial consumer sector of our economy.

Individuals who engage in intentionally corrupt financial practices or reporting betray their duty to the entity that employs

them, their responsibilities to shareholders, and their obligations

under the law. But unlike these real persons, corporations and

other business entities cannot think or act for themselves.

Thus, while individuals can, and do, form the corrupt intent that

defines criminal behavior, to ascribe criminal intent to a corporation is a judicially-created legal fiction endorsed by the Supreme

Court in 1909. Even though legally permissible, sanctioning a corporation for a crime may be less effective than some alternatives

in influencing positive corporate behavior.

I honestly believe, and candidly say so, that neither new crimes

nor increased penalties alone are going to solve our problems. In

fact, we might remember that in the real world excessive exposure

to draconian sanctions in economic crime cases has the potential to

discourage meaningful corporate critical self-examination, as well

as disclosure, cooperation, and guilty pleas by individuals and companies. In addition, as initiatives are considered, reviewing relevant and fundamental precepts of our constitutional system can

provide some invaluable guidance.

It is, for example, helpful to recall that a core function of the

Federal establishment is to promote and secure the benefits of commerce to the people. In harmony with this purpose, for over 200

years the Federal criminal law applicable to commercial activity
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was aimed at protecting the means and instrumentalities of commerce.

Surely, capital and credit markets are obviously key means and

instrumentalities of commerce, and protecting them from corrupt

practices is consistent with this core Federal role. The question,

though, is how best to do that, and it seems to me that the answer

is not to reflexively create new offenses or simply impose greater

sanctions. Rather, it may be more efficacious to seek a balance, including incentives for good corporate practices, correction and reform of questionable practices, and reserving effective sanctions,

and severe ones, for truly corrupt practices.

There are alternatives to corporate criminal prosecutions that

can help restore confidence in our companies and our financial systems. First and foremost, as the President recognized yesterday,

corporations themselves need to do more to promote confidence in

their own performance and in their financial reporting.

Steps include more active internal oversight, including through

board audit committees. Internal auditors and audit committees

can be highly effective inside watchdogs. It is better to have financial reporting that gets it right the first time.

Likewise, corporate legal officers and auditors should not merely

empowered, but encouraged and provided the resources to

proactively investigate internal malfeasance. This is not only good

public policy, but has significant value in protecting corporations.

The Government can do much to encourage critical self-examination by corporations and other business entities. Real incentives

rather than just rhetorical ones should attach to voluntary correction and disclosure of wrongdoing. I must report to you that most

attorneys advising companies today are forced to conclude that the

benefits of voluntary disclosure are insufficient to outweigh the

risks attendant to them.

As an example, even a limited waiver of attorney-client privilege

requested by prosecutors can result in a complete loss of privilege

in related civil proceedings by private parties. Congress could consider a statute making limited waiver agreements with enforcement authorities enforceable against third parties. Although this

may sound radical, particularly at this point in time, as a matter

of prosecutorial policy business entities that make timely disclosure

of wrongdoing might enjoy a presumption, not a bar, but a presumption against criminal prosecution.

I do not advocate going lightly on real cheats and crooks. A dishonest market is not a free one. But we must also work to discriminate between conduct that merits the harshest sanctions and that

which can be addressed more effectively through alternate means.

Because facilitating commerce is a core Federal responsibility, we

should police the marketplace, in my judgment, judiciously, utilizing good judgment and discretion in establishing and assessing

sanctions for commercial misconduct.

Mr. Chairman, I would ask to submit the balance of my statement for the record, if I may, and thank you very much for having

me.

Chairman BIDEN. Without objection, it will be. Thank you for

being here.
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[The prepared statement of Mr. Terwilliger appears as a submission for the record.]

Chairman BIDEN. Mr. Devine?

STATEMENT OF TOM DEVINE, LEGAL DIRECTOR, GOVERNMENT ACCOUNTABILITY PROJECT, WASHINGTON, D.C.

Mr. DEVINE. Thank you for inviting my testimony.

It is rare for the Government Accountability Project, but my primary goal this evening is to offer credit where it is due. Through

the provisions creating state-of-the-art whistleblower protection

that were unanimously approved by this committee and on the

Senate floor this afternoon, the Judiciary Committee exercised bipartisan leadership for a genuine breakthrough in corporate accountability.

The Corporate Fraud and Accountability Act of 2002 is outstanding, good-government legislation. It complements your leadership

in today’s hearing. The Act’s centerpiece is legal rights for whistleblowers at publicly-traded corporations. Future Sherron Watkinses

could not be fired at will for warning corporate leaders or shareholders of consequences from cheating, such as bankruptcy liability

or other risks that could sabotage investments.

The strategy is creating a safe channel for shareholders’ and

management’s right to know, as well as for testimony in law enforcement investigations. The goal is to frustrate cover-ups by giving reprisal victims access to district court jury trials if they cannot

receive a timely decision from what all too frequently has been the

black hole of the Department of Labor’s administrative law system.

For example, our organization has represented a client with a case

pending there for 14 years. The cases would be governed by the

modern legal burdens of proof that Senator Grassley helped create

in the Whistleblower Protection Act of 1989 for Government workers.

Disclosure has been the trans-ideological, bipartisan cornerstone

of all post–Enron reform proposals. The common-sense logic is unassailable. Two long-accepted truths are, first, that secrecy is the

breeding ground for bureaucratic corruption, and, second, that sunlight is the best disinfectant. Otherwise, even the best corporate

leaders are ignorant of misdeeds until they are being blamed for

the consequences. Similarly, shareholders are blind-sided by risks

being taken behind their backs. The ultimate fate of the Judiciary

Committee’s whistleblower legislation will confirm whether political leaders are serious about disclosure.

Whistleblowers are the Achilles heel of bureaucratic corruption.

As the eyewitnesses to the birth of scandals, they are indispensable

to bridge the secrecy gap. Their free speech right is more than just

the freedom to protest misconduct. It also includes the freedom to

warn.

In the Netherlands, for example, these individuals are called

bell-ringers, after folks who climbed the church tower to warn the

community of danger. In other nations, they are called lighthousekeepers, after those who shine the light on rocks which could sink

ships arriving in their harbors or ports.

The common theme is warning about threats to the public’s wellbeing before avoidable crimes or disasters occur and before we are
192

limited to damage control. Over and over, their dormant potential

has been proven anecdotally since the 1980s. The common theme

in the disclosures of whistleblowers represented by the Government

Accountability Project has been warning of liability or Government

sanctions for cheating.

Sherron Watkins acted as a corporate Paul Revere by warning

that devastating liability was coming. Enron chief Ken Lay ignored

her at his own peril and sealed his doom. These people are the lifeblood of anti-corruption campaigns, which are lifeless, empty symbols doomed to failure without testimony from those who bear witness. It is just a truism to share with some of the folks I am talking within this audience that it can be very difficult to win criminal

convictions without leads and testimony.

Whistleblowing disclosures to the SEC doubled during the Enron

hearings, and the SEC enforcement chief commented, ‘‘Because of

this phenomenon, we are learning of potential securities law violations earlier than ever before. Keep those cards and letters, not to

mention e-mails, coming.’’

But unless rights are locked in, things will soon be back to normal and would-be whistleblowers will decide instead to stay silent

observers. Ironically, except for Senator Grassley’s work on the

False Claims Act, the norm is that whistleblowers proceed at their

own risk when sounding the alarm.

Corporate law is a crazy quilt of hit, or usually miss, protections

for everything except the False Claims Act. With scattered exceptions, the lucky ones who have coverage are prisoners of the Department of Labor’s administrative law system, and the norm there

is well over two years to get a decision, with no chance for interim

relief. That is professionally akin to patients who die while they

are waiting for the operation to occur, while they are waiting for

an organ donor or something like that. Ms. Watkins only survived

because Enron collapsed before retaliation could be carried out, and

then she became a celebrity. For whistleblowers, the sad truth is

that if you are not a celebrity, you are cooked.

As Professor Fred Alford of the University of Maryland observed,

for every Sherron Watkins there are several hundred whistleblowers who lack the protection of visibility. These people are openly fired for disloyalty to company managers who themselves often

were breaching their fiduciary duty to the shareholders. It really

raises the question, loyalty to whom?

Initially, this reform appeared trapped by a partisan deadlock,

but thanks to work beyond the call of duty by Senators Leahy and

Grassley’s staff, we achieved a composite model that sparked a consensus. The Judiciary Committee’s compromise is a win-win for everyone, except corporate crooks.

Honest managers, boards, shareholders, whistleblowers, and Federal law enforcement agencies will be empowered with an earlywarning system to prevent new Enron disasters by nipping scandals in the bud. It would place the United States in compliance

with the whistleblower requirement in international anti-corruption treaties.

The unanimous committee approval in today’s vote suggests the

Senate may be ready to prove it is serious about making a difference, and that is a welcome development. Legislators of both
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parties have rhetorically lionized whistleblowers and chastised

those who violated their duty by remaining silent, but it is time to

add genuine rights to this rhetoric. The rhetoric rings hollow to

someone who is fired and facing bankruptcy for warning a corporation of that same risk.

The legislation adopted by this committee should be a beachhead

for other stalled pending legislation, especially S. 995, amendments

to revive the Federal Whistleblower Protection Act, which was the

strongest free speech law in history when unanimously approved

by Congress in 1989 and strengthened in 1994.

But after brazenly hostile activism by a court with a monopoly

on judicial review, it is a trap that creates more victims than it

helps, and our organization, which worked to pass that law, has to

warn people against using it. There is also legislation to provide

whistleblower rights for FBI employees, also approved by this committee, and Federal baggage screeners, introduced by Senators

Grassley and Levin, which would close inexcusable loopholes.

These bills badly need bipartisan sponsors, and I hope there will

be an opportunity to work with your staffs on this legislation.

The Judiciary Committee bill is only a first step, but it is a giant

step forward. It means that future Sherron Watkinses will have

rights when they risk their personal financial future to defend that

of the shareholders. It is unrealistic to expect that whistleblowers

will defend shareholders or the public if they can’t defend themselves. Like current corporate whistleblower law, profiles in courage are the exception, not the rule.

Thank you.

[The prepared statement of Mr. Devine appears as a submission

for the record.]

Chairman BIDEN. Thank you very much, all of you. The Senator

and I are used to working together, and since there is the two of

us, we are just going to sort of have a conversation with you, okay?

Mr. COFFEE. Senator, I have to leave in about ten minutes to

make my airplane, which is the last plane of the night going back

to Newark.

Chairman BIDEN. We will have a conversation with you first, if

we can.

Let me say sort of as a context for the few questions I have that

I want to make it clear that I, for one, do not believe that merely

changing criminal penalties and sanctions is going to solve this

problem. I do agree with you, Mr. Terwilliger, that the loss of faith

we are experiencing now may produce overreaction.

I have been involved either directly or indirectly or literally writing every major criminal law, for good or bad—I made some big

mistakes, like the crack cocaine question—since 1984.

Mr. TERWILLIGER. Mr. Chairman, if I may, I don’t mean to interrupt you, but I know you have, having worked directly with you

when I was Deputy Attorney General. You have been a member of

this body that has certainly put no partisan interest in the way of

very truly substantive work for the benefit of the criminal law.

Chairman BIDEN. Well, I thank you.

Let me tell you I am worried in this moment that we find ourselves, and the extent of the anger that is palpable. As you all
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know better than I do, more people are, quote, ‘‘in the market’’

now, average people. It is amazing.

I commute everyday. The conductors come up to me. These guys

are blue-collar workers, my buddies, and they are in the market.

I mean, their 401(k)s are in the market, but they personally are

dealing on their computers; they are day- trading. I don’t know the

number, but I think——

Mr. COFFEE. I know the number. Eighty-eight million Americans

directly own stocks or mutual funds.

Chairman BIDEN. Is that a higher percentage than in the 1920s?

Mr. COFFEE. About 50 percent of American households have a

stock investment. In Europe, it would range between 15 percent

and 12 percent, so we are three times more invested than any maximum in a European country.

Senator SESSIONS. Mr. Chairman, Professor Coffee has to go in

just a minute. I had one question.

Chairman BIDEN. Go ahead, if you have a question for him directly.

Senator SESSIONS. My question was when you talk about a special counsel, would that be something like what happens in bankruptcy where a trustee comes in, but this company may not be in

bankruptcy?

Mr. COFFEE. It could be very similar to that because the trustee

takes over the board’s powers

Senator SESSIONS. They would sue the officers to recover assets

for the company?

Mr. COFFEE. I don’t want to supplant the board of directors generally. They should still be the decisionmaking organ. But with regard to the decision, do we sue the former chief executive who was

our friend and colleague, do we sue the controlling shareholder who

has a lot of friends on the board—that is the world where in the

appropriate case the probation condition could be one under which

the court appoints an officer who will make a disinterested decision

and who will not be motivated, as plaintiffs’ attorneys sometimes

are, by the prospect of a one-third recovery. It will be more of a

fair, independent decision.

Chairman BIDEN. Well, let me speak to that for a second. What

is the problem with motivating an attorney? I mean, I find this

kind of interesting. Part of our English jurisprudential system for

800 years has been, before Adam Smith and since Adam Smith,

that if, in fact, you do not want government to grow and government to—and I will put this in the most base terms I can—and if

you cannot have or do not successfully have self-effectuating mechanisms that the industry places upon itself or individuals do, then

we basically have said as a part of our capitalist system that what

we will do is we will incentivize people to allow stockholders and

allow investors to, in fact, stop bad behavior that occurs, whether

or not they can recover everything that they want to recover.

To put it in its most naked terms, thank God for vultures; they

clean up the roadkill. Let’s assume that every plaintiff’s attorney,

which seems to be what is the view in this town the last ten years,

is a vulture. I disagree fundamentally with that, but let’s assume

they are.
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Mr. COFFEE. I am not disagreeing with that, Senator. In fact, I

was the special counsel to the White House general counsel office

during the passage of the PSLRA, and I do agree that there is a

role.

The special problem about derivative actions is that unlike the

class action, where it tends to be a kind of joint venture in which

the legal entrepreneur gets 25 to 30 percent if the recovery, in a

derivative action very often the plaintiff’s attorney is able to settle

on a cosmetic basis and, in effect, preempt the entire recovery. You

get a settlement for cosmetic relief and you get a several-milliondollar award in attorney’s fees, and I think that does not serve well

the shareholders.

Chairman BIDEN. Now, let me speak to that one way and then

let you go, because I am told you must leave very soon. If the issue

is that that action, the derivative action, overcompensates the attorney and under-refunds, if you will, the stockholder, that

wouldn’t even matter to me if, in fact, it affected corporate behavior.

Are you suggesting that it doesn’t affect corporate behavior?

Mr. COFFEE. I really have two points here.

Chairman BIDEN. I am not disagreeing. I am trying to understand you.

Mr. COFFEE. I served for 13 years as the reporter to the American Law Institute for its Litigation Remedies Section as part of

the restatement of corporate governance.

Chairman BIDEN. Right.

Mr. COFFEE. The problems with the derivative action are that it

is almost impossible to bring one because of what is called the demand rule, which is probably the best known body of law among

Delaware lawyers. They all know the demand rule and the exceptions to the demand rule, and I am good friends with many of those

judges.

Because the derivative action is subject to that very high burden,

the appointment of a special monitor who could sue in the name

of the corporation avoids the derivative suit problems. It allows you

to bring an action as the corporation suing in its own name, as opposed to a small shareholder going through a court of equity and

seeking to get permission to commence a derivative action.

It is both a more effective remedy and I think it is one in which

there won’t be quite the same compensation problems in which you

may get a cosmetic and meaningless relief in return for a high

award of attorney’s fees.

Chairman BIDEN. I know you have to go, so you should go. I am

not suggesting that your suggestion is not better. I am just trying

to understand whether or not the reason why the derivative actions

are not as useful is because the burden that has to be met is so

high.

Mr. COFFEE. It is a very high burden.

Chairman BIDEN. If that is the reason, or because, even if the

burden is met, it does not result in affecting corporate behavior.

Mr. COFFEE. I think both of those diagnoses apply to some cases.

Chairman BIDEN. Thank you for being here. I appreciate it. With

your permission, on your way out, we may submit to you a couple

of questions in writing, and I know you are busy.
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Mr. COFFEE. I really apologize.

Chairman BIDEN. No. You hung around here for two hours.

Now, let me continue to pursue that for a minute and ask any

of you to chime in here. Professor Elson, as well as Professor Donaldson, if you can put on the portion of your professorial hats that

has a historical perspective here, what is the history of the role of

government enforcing these ethical standards on corporate behavior, building in mechanisms that are designed as part of the capitalist system to be sort of self-cleaning, like allowing and

incentivizing stockholders and/or aggrieved parties and/or entrepreneurial lawyers to enforce proper behavior?

Talk to me about that just a little bit. I am not getting into any

specific actor. Just tell me about what the role has historically been

of those two functions, because my understanding has generally

been the last thing you want is you want a large government enforcement regulatory role that does have, I think, the potential to

have a deflating sort of impact upon corporate ingenuity, corporate

growth, corporate innovation.

So talk to me about that, if you will. That is not a very well articulated question, but I hope you know what I am trying to get

at.

Mr. ELSON. I think that the key is how you create compliance

with law within the organization. That is a fundamental issue. We

have attempted lately to create bureaucratic mechanisms within

the organization, compliance committees and what not, and this

comes out of the Federal Sentencing Guidelines and out of the

Caremark case, to do it. They were, as I think Professor Donaldson

pointed out, ineffective.

The real key is creating within the organization an ethical culture. That comes from the top, that comes from top management.

And who is responsible for top management? It is not the government or even those who bring litigation under the securities laws.

It is really the board of directors when you get down to it. They

are the shareholders’ representatives who are there to oversee the

organization.

Unfortunately, boards have fallen very short lately, for the reason that they were typically managers. They were insiders on the

boards or those who were friendly with management or had relationships to management, which made it impossible to monitor.

That is why modern corporate guidance—and I am wearing my

governance hat now—calls for independent, long-term, equity-holding directors as the real solution here. I think those of us in the

governance community have been arguing this for a long time.

Chairman BIDEN. How do you get there, social disapprobation?

Mr. ELSON. You get there through institutional investors and the

stock exchanges, which they are proposing now, to call for substantial majorities of the board to be independent, no financial connection at all to the company other than equity ownership. Independence gives you objectivity in reviewing what management is up to.

Equity gives you the incentive to exercise that objectivity.

I think when you have that kind of board, the whistleblower,

who I think is a very important party, has a group to go to. At this

point they don’t, where they are captured by management. If the
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board is dominated by management, there is no point in the whistleblower going forward.

On the other hand, if the board is independent or the audit committee is independent, obviously there is an incentive there for

someone who disagrees with what management is doing to come to

that body, who are acting in the company’s interest as shareholders. I think that that is really the key, at least in my view, to a

solution.

Otherwise, you are going to have a regime which is fabulous for

the lawyers. And as a member of that profession, I am not too unhappy about that. On the other hand, it will be form over substance, and I think that is what we have gotten and that is why

we find ourselves in the pickle we are in.

Every company that has had these ethical issues the last couple

of years all had codes of ethics, compliance programs, toll-free hotlines, and none of it made a difference.

Senator SESSIONS. To interrupt there, isn’t the board relying to

a large degree on the accounting firm?

Mr. ELSON. Yes, absolutely.

Senator SESSIONS. So the accounting firm is the one that is supposed to be the paid whistleblower, isn’t it?

Mr. ELSON. Well, the internal audit and external audit, yes, they

were. Unfortunately, there was a linkage or relationship between

the accounting firms and the managers, which made it more difficult. And I could go into a lot of explanation for this as to why

they didn’t come forward or didn’t look hard enough.

I think one of the problems was they believed that the audit committee itself was dominated by the management and there was no

point in going to them where there were disagreements, because

you were effectively going back to the same party. That is why

independence on the part of the audit committee is so critical so

that the independent auditors feel some sort of comfort in going to

that group, and having the auditors report to the audit committee,

be engaged by the audit committee.

Senator SESSIONS. Just one more little question. So you are calling for a new kind of board? I mean, the boards that are presently

constituted today, many of them do not have the time nor the expertise to challenge an auditor or a financial accounting plan established by management, right? Aren’t we asking a lot of them?

Mr. ELSON. No. I am calling for the same kinds of boards; I think

different composition, though. The job of the board is to monitor,

not to run the business, but to monitor.

Senator SESSIONS. Monitor?

Mr. ELSON. Right, and monitor means ask good questions, or if

someone comes to you with a problem, listen to them. But if you

are perceived of as part of management, then no one is ever going

to bother to come to you. Or if you are too linked to management,

you are never going to bother to make an issue, for fear of being

replaced on the board.

That is why independence vis-a-vis nominating committees, visa-vis the audit committees, and vis-a-vis compensation committees

is really the solution. That is what institutional investors have

been arguing for for the last five, six years. We are moving in that

direction. That is the ultimate solution, at least in my view.
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How do you stimulate this monitoring mechanism, known as the

board, to do its job effectively? I think it has to do with independence and long-term equity ownership on their part. I am not saying

that the board should run the company. That is silly. They don’t

have the time, expertise, the will, or the patience. On the other

hand, their job is to hire good management, monitor good management and, when necessary, fire bad management.

Chairman BIDEN. Professor Donaldson, can you give me a little

history lesson here?

Mr. DONALDSON. Well, I sense in your question a concern that I

think has been reflected by smart people throughout history for

something other than a command and control model of managing

large-scale entities. It is at least as old as Montesquieu. It probably

goes back to Aristotle.

With the exception of corporate governance changes, I think the

corporate criminal sentencing guidelines are one of the first and

most innovative attempts to try to build in, rather than impose on,

certain kinds of corporate virtues. For that reason, I found the idea

very attractive, and I still do.

In practice, however, with limited resources, what has happened

is that the Federal people have not been inclined to bring suits

against large corporations, have often cut deals with this phenomenon that one of my colleagues calls reverse whistleblowing; that is

to say the entity will provide information about usually lower-level

white collar criminals and as a result a few people may go to jail

or may be fined. But the compliance programs themselves are rather ineffective when it comes to the kind of Enron/WorldCom scandal.

I still believe in that. I wrote about that in a book I published

in 1982; that is, building it in instead of imposing it from the outside. For this reason, expensing options, restricting the time in

which executives sell shares that have come from options, requiring

shareholder approval of options plans, all of which have been discussed, I think are critical adjustments to the mechanism that will

realign incentives and make things different.

In terms of compliance programs themselves, I don’t want to do

away with them. But, for example, most of them have these whistleblowing provisos already built in, but they tend to go to the legal

department. They aren’t connecting to auditing. They need to be

changed.

Chairman BIDEN. Let me say it a slightly different way, then.

Again, I am not trying to make a case for this. I am just trying

to understand. Let me just tell you a little story and then have you

react to it.

I come from the corporate State in a literal sense in terms of the

culture of the State. I was attending a meeting in the Hotel DuPont and I came out of one of the conference rooms where they

have meetings and a group of high-level executives from other

States were meeting. One individual said I knew said they wanted

to introduce me to these people. There were two meeting rooms and

we just literally met in the hallway.

Most of these people are of a different party than I am, but this

guy supported me and he said, ‘‘I want to introduce you to my

friends,’’ and these were major CEOs of major companies. He intro-
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duced me to one and this guy said you know, I like you very much,

Senator, but I don’t understand why you are always with the trial

lawyers on this tort reform stuff.

I looked at him and I said, because I am trying to save your soul.

And he looked at me and he said, well, what do you mean by that?

And I said, well, you know, all the incentives are built in in a way

that make it very difficult, with your fiduciary responsibility to

your stockholders, to make some very difficult decisions. I went

through this little thing and I said, so if you are faced with the following problem I outlined, which I won’t bore you all with, it is a

very tough decision you have.

I said, but if you know that all that can be collected is the outof-pocket expenses, the personal injury if your widget blows up and

hurts everybody, you are going to have to ask a logical question.

You are going to bring in your quality engineer and say how many

of these are likely to blow up? And he is going to say 1,000, or

10,000. And you are going to bring in your legal counsel and say

what is my outside liability if I do this?

I said maybe you are different. Maybe you will say it is just

wrong and I am going to do the right thing, and get fired by the

board. Then you are going to add it and it is going to be $20 million

to recall this and your total exposure is $3 million.

I said I don’t want you to have to make that tough decision, because let me tell you guys, as Ralph Waldo Emerson said, society

is like a wave; the wave moves on, but the particles remain the

same. We haven’t made a new brand of man in a millennium. Corporate executives are just as good, just as bad, just as venal, just

as noble as everybody else.

For example, I always get the Chamber of Commerce guys telling

me about the coupon case, where one of the airlines overcharged

everybody an average of, I don’t know, two dollars. I forget what

the number is. No one customer lost more than $200 or $500, and

yet the lawyer got a $20 million fee. Do you know what my answer

is? So what, so what?

What happens if we found out—and we don’t know this, but let’s

assume one of the major oil companies just owns their gas stations

and clicks back—for every 100 gallons sold on that machine, they

really only sold 99.7. Nobody, no matter how much gas they guy,

is going to have lost more than $100, $200, $300, $1,000. It is going

to cost them $25,000 or $30,000 to go hire you or me.

I was relatively good at what I did and I get job offers that are

astounding in the amount of money the law firms want to pay me

to come back, literally astounding to me, anyway, for a guy of my

salary.

It is going to cost a lot of money to sue xyz corporation, so guess

what? It doesn’t bother me a bit that some lawyer goes out and

puts together a fund of $6 or $8 or $10 million to go after the oil

company and sue them. The class that is suing, each person only

gets back $175 of what they lost and the lawyer makes $20 million.

What incentive is there other than pure honesty, pure desire to do

the right thing, social disapprobation? No government is going to

come and do anything about it. The Government didn’t go after the

tobacco companies, nor would they. Thank God for Dickie Scruggs.

He made obscene amounts of money. So what?
200

Now, you guys in the corporations always tell me don’t do criminal penalties and, by the way, raise the bar on the area where we

can get sued because of frivolous lawsuits. And you are coming

along, Professor Elson, and saying, you know, just do the right

thing.

What do we do about this balance?

Mr. DONALDSON. If I could add, I spent three days on the witness

stand testifying against the tobacco industry in the trial that was

terminated as a result of a $300 billion-plus settlement. I think

there is a very important role for people making a lot of money

when they create an enormous contribution in the way that that

happened. So I very much agree.

Now, that is not to say that they haven’t been used excessively,

class action suits, in some instances.

Chairman BIDEN. They have. I don’t have any doubt about that.

Mr. TERWILLIGER. Mr. Chairman, if I may, I just want to go back

to a point that you made before that I think is an excellent one and

deserves emphasis. You really asked what I think is the right question: How do we most effectively influence positive corporate behavior?

Chairman BIDEN. Right.

Mr. TERWILLIGER. A lot of what we talk about doing of necessity

is dealing with that behavior after it has occurred and imposing

some kind of sanction which may be as the result of a tort lawsuit.

It may be a criminal sanction, it may be a civil enforcement action.

But there are other issues, I think, that are worth looking at

about how on the front end of that process can we affect it, and

some of what——

Chairman BIDEN. Can I stop you there?

Mr. TERWILLIGER. Yes, sir.

Chairman BIDEN. Don’t lose your train of thought.

I am assuming, as I have as a lawyer and as a Senator, that this

does affect the front end. What is the rationale for punishment? It

is not retribution. It is to incentivize someone to do the right thing.

What is the incentive for these civil lawsuits brought by individual

stockholders? It is if they know it can be brought, they are more

inclined not to do it.

So I wouldn’t make an artificial distinction here that this is only

after the horse is out of the barn. I assume criminal statutes we

are talking about are to be a disincentive to do bad things.

Mr. TERWILLIGER. Of course, yes, and I agree with that and I

don’t mean to suggest that they are not.

Chairman BIDEN. I am not sure how good they are.

Mr. TERWILLIGER. Well, that is the point. The point is that if we

exclusively focus on those after-the-fact solutions, then I think we

lose the opportunity, and particularly the opportunity for the Government to be part of the package to incentivize other kinds of behavior.

The first responsibility is in the corporations themselves. Then

the question becomes what can the Government do? Some of the

things that it can do is remove some of the incentives to bad behavior and reward incentives for good behavior.

Right now, our whole system of reviewing public accounting is

geared toward singling out those companies who don’t do it right.
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Why can’t the Government and the accounting industry and business get together and identify what are the best accounting practices and recognize those companies that engage in them? That has

as very beneficial effect for investors, in that they know that this

company is not playing fast and loose, and I think there are other

things of that nature.

My concern is that if we try to simply deter through sanctions

that we will not really take advantage of this opportunity to do

some other things that can be very positive.

Chairman BIDEN. That is my whole point. I am not stating it

well. I would like to figure what are those things that aren’t Government regulations or Government sanctions criminally that can

incentivize.

Let me give you an example. I guess it has been six, eight

months, maybe longer, but I was meeting with a personal friend,

a good acquaintance at home, a CEO of a major corporate company.

It was in a social setting.

He said, do you know what galls me? He said, I go up and I sit

down with a bunch of guys on Wall Street who summoned me to

Wall Street. I sit down with three or four or five people—I forget

the number he said, but a small number—average age, probably

30, and they are looking at me and saying, okay, what is the next

quarter going to be? What are you doing next quarter?

And he said, well, we are going to continue to build this and we

will maintain the same return on investment next quarter. No, no,

no, that is not good enough. We are going to have to essentially

downgrade your outfit unless you can show us you are going to

have a growth of 1 percent or a profit of whatever.

And he said I have three options. My first option is I can tell

them to go to hell, and the value of my stock falls, the value of my

company falls, even though I am doing just fine, but I am not meeting their expectations.

The second thing I can do is I can go home and say, okay, I can

cut expenses. So I go home and fire people, because now what I

have done is my profit margin is slightly higher.

Or, three, I can have a new product in my pocket that I can put

out there, but I don’t always have that. So what do I do?

Then they say to me, okay, now part of my compensation, a gigantic part of my compensation in some cases is the stock option,

and I have ‘‘x’’ amount of time to exercise that option. I am not stupid, Joe. I know if I don’t meet these projections expected of me by

these guys on Wall Street, who don’t know squat about my business, the value of that stock is going to fall.

Now, is he wrong about that? Is that not how it works?

Senator SESSIONS. Life in the big leagues.

Chairman BIDEN. That is right.

Senator SESSIONS. You either have to perform or you get downgraded, but he has got to have integrity.

Mr. DONALDSON. You are running the company for the an analysts and not for the company.

Senator SESSIONS. Analysts represent investors, and the investors have a right to ask questions. But we shouldn’t be whining

around here about the poor CEO who therefore cheats to satisfy

some demanding investor.
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Chairman BIDEN. I am not whining about anything. I am just

trying to understand.

Senator SESSIONS. He has to have the integrity to do the right

thing or else his fanny goes to the slammer.

Mr. ELSON. The CEO is wrong to answer you that way.

Chairman BIDEN. Say again.

Mr. ELSON. The CEO is wrong to answer you that way.

Senator SESSIONS. I didn’t like that answer.

Mr. ELSON. I don’t think it is the appropriate answer. The answer is most of the institutional investors who are with you in your

stock are indexed, which means they are locked in with you for the

long term. They can’t buy or sell. They have got too much in you

and they go on everyone. That is number one, so they are with you.

If you can convince the world that you have long-term prospects

for your company and you are locked into the stock long term and

you can’t take your options, exercise them and move on—that has

been the problem lately. People take the stock, they sell it, and

they leave. The idea is you have got to be locked in for the long

haul.

At that point, I think your decisionmaking as an executive or as

a board reviewing an executive’s decision is appropriate. You can’t

run a company on a quarter. You have to run a company over the

long term. What happened was I think our incentive systems went

out of whack, not that equity compensation was wrong, but it was

equity compensation that you could sell.

In fact, everyone who has been advocating equity comp for directors for years has said it has got to be restricted for your service

term on the board. If you allow someone to sell it short term, you

take advantage of informational advantage or short-termism that

in the end is devastating to the company.

Chairman BIDEN. What is the primary practice right now in, say,

the Fortune 100 companies in America? In the compensation that

they get in stock, are they able to sell it short term or are they required to hold it long term?

Mr. ELSON. Well, you have insider trading regulations that make

it tougher to sell the stock. But as we saw in Enron and these

other companies, people were dumping massive amounts of stock.

That was the problem. And, frankly, I blame their boards on it, too,

because why didn’t the board say why are you selling all this stock?

It is a terrible sign to our investors that you are leaving. If you are

selling it, you have obviously found a better place to put the

money.

Chairman BIDEN. Excuse me. I got that. I understand what happened. What I am asking you is in most of the compensation

plans—I don’t know if there any such study out there, but if you

took the Fortune 100 companies and you looked at compensation

and you looked at the portion of compensation related to stock, not

direct salary, can you generalize for me or are there any studies

done saying that 75 out of 100 of the top 100 require you to hold

it for four years?

I mean, is there any pattern, and has it changed? Something has

happened, fellows; something has happened in the last 15 years. As

they used to say when I was a kid, something is rotten in Denmark.
203

Mr. DONALDSON. That is right, and I don’t know of the studies.

I suspect we could find some. Certainly, it is the minority of business leaders today who are standing up, but there are few courageous ones, and saying we have all got to play the game this way;

we have got to have limits on when we can sell the stock and they

have got to be significant.

Mr. TERWILLIGER. I think that is an important point in terms of

the equality of treatment. I mean, let’s face it, the competitors of

some of these companies were put at a great disadvantage in the

stock market if these companies were cheating on what their companies were really worth through false financial reporting. That

gives all of business an incentive to play it right.

I think one of the things we keep hearing over and over in this

discussion from Professor Elson is the role of the boards. I really

think that illustrates a point that a lot of this has to do with holding businesses accountable for how they run their businesses.

Going back to your point of how you incentivize this, there is no

one answer. There are a number of ways in which they are held

accountable, but in our system at least the principal responsibility

is that of the board to the stockholders to make sure that that business is being run in their best interest, not in some cadre or group

of conspirators among senior management who are self-dealing.

Mr. DEVINE. Senator, one suggestion would involve an expanded

model of whistleblower rights. Protecting whistleblowers is one way

to maximize accountability, while minimizing the size of Government intervention that is a necessity, but it is only one side of the

coin.

The other side is making a difference with their disclosures. The

point of whistleblower protection is to make a difference, not to

make noise, and one thing that I would suggest for you folks to

start considering is a way for them to have more impact through

their disclosures than just putting something on the record.

Senator SESSIONS. Getting more what, impact?

Mr. DEVINE. Getting more impact. There are two precedents that

could be considered. One is the disclosure mechanism in civil service law in the Whistleblower Protection Act. Whistleblowers don’t

just defend themselves under that law; they can challenge betrayals of the public trust by making formal disclosures to the Office

of Special Counsel, a Government agency.

If the Special Counsel finds a substantial likelihood they are correct, they order the agency head to investigate and report back

what they are going to do about it. The Special Counsel, with the

whistleblower’s comments, evaluates whether that was a good-faith

resolution of the alleged problems and places it all in the public

record.

Something like that could be developed for the Securities and Exchange Commission, where whistleblowers could make disclosures

of significant misconduct to SEC, and if the agency found a substantial likelihood that the charges were well taken, to order, akin

to what Mr. Sporkin did after the political payments scandals in

the early 1970s, a board investigation and report back on how they

were resolving the problems.

Chairman BIDEN. Well, you know, there is an old expression: you

have to know how to know. Whistleblowers don’t always know. I
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mean, we are fortunate if there is a whistleblower in a position

where there is an intersection of information that they are aware

is, in fact, inappropriate.

For example, the report released on Sunday by the Senate Permanent Subcommittee on Investigations concluded that members of

Enron’s board of directors contributed to the firm’s collapse by,

among other things, failing to curb the company’s risky accounting

tactics and by approving conflicts of interest.

The report cites several red flags since February 1999 that arguably should have triggered concern among the board members, including notice by auditors that Enron was using questionable accounting methods and requests to waive the company’s conflict of

interest policy.

To what extent are directors now held liable for misdeeds of company executives, and to what extent should they be sanctioned?

Mr. ELSON. I testified before that committee and some of the red

flags that they talked about were some of the things I talked about

in the report. I think the problem on that board was independence.

The red flags were there. I mean, waiving the code of ethics was

an incredible red flag that was missed. That was extraordinary.

Chairman BIDEN. Waiving the conflict of interest?

Mr. ELSON. They voted to waive the company’s Caremark conflict

of interest policy, which is sort of like saying let’s say no speed limits for an hour and see what happens, which obviously doesn’t

make a lot of sense.

The point was why did they do it, and I believe that it had to

do with an independence issue. I think that there were independence problems on that board which caused them, I think, to view

what management was telling them vis-a-vis those flags not in the

same light that others who were independent would view those

flags.

Chairman BIDEN. How do we get independent boards, then? Do

we just count on this public disclosure generating that?

Mr. ELSON. The latest New York Stock Exchange and Nasdaq reports on corporate governance have called for listing standards that

require majorities of corporate boards to be independent, and by

independent they mean no financial connection to the company or

management other than long-term equity ownership. I think that

that is the key.

Chairman BIDEN. Didn’t they discourage that? Was that not proposed earlier, as well?

Mr. ELSON. Well, no, it has never been proposed. The institutional investors and the Business Roundtable that five, six years

ago and it never went anywhere.

Chairman BIDEN. Why?

Mr. ELSON. Well, I think that there were a lot of management

who didn’t want to have an independent board, for obvious reasons.

Chairman BIDEN. Bingo.

Mr. ELSON. Yes.

Chairman BIDEN. So it didn’t get adopted.

Mr. ELSON. Well, it began to be adopted. You have seen many,

many companies over the last four or five years that have moved

to substantial majority independent boards based on investor pressure. Large institutions—Calpers, TIAA–CREF, the New York
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State and City funds—put pressure on boards to reform and you

began to see changes.

Chairman BIDEN. In the meantime, though, a lot of people are

dead. I mean, it is a little bit like saying we need more cops in a

crime-ridden area and the public is going to put pressure on the

local councilmen to vote to do that, but it is going to take a while

here and my neighborhood is still—I mean, I don’t get your guys.

Mr. DONALDSON. There are always clever things that can be

done. In the Enron case, for example, the audit committee, sort of

the focus on the problems—half of the people lived outside the

country. Everybody on that six-member board had something big in

their pocket from Enron, and the head of the audit committee had

been there for 13 or 14 years. This is very bad practice. So some

of the reforms that are working on board and audit committee relationships to the corporations and other systems are important. I

like, for example, the idea of having the audit committee pick the

outside auditing firm instead of having that picking being done by

the CEO.

Mr. ELSON. They should have done that to begin with. You are

absolutely right. To begin with, the reporting line should have been

to the audit committee. But these changes have been taking place

over the last couple of years. I think what you have seen are

outliers. Listen, I believe strongly in substantial majority of independent boards. I would go beyond simply majority.

Chairman BIDEN. Let me tell you what worries me. In a sense,

this whole subject is above my pay grade. This is not something I

claim any expertise in. I am going to say something outrageous.

Regarding the criminal justice system and criminal behavior that

is violent criminal behavior, I believe I know as much about that

as anybody who has served in the United States and almost any

criminologist in the country, not because I am so smart, but for 30

years I have listened to every single expert we could find, and I

hope I am not stupid.

This is above my pay grade, in a sense. But do you know the people I listen to? I listen to the people who, in fact, are deeply invested in this capitalist system, and they have concluded, in my

view, that this is a systemic problem. This isn’t a few bad apples;

this is systemic.

You have the Nasdaq at a five-year low after the President’s

speech. You have the Dow down to 8,813 at the close of business

today. You have almost every major business leader I know and not

because I am important—I think I am probably the only guy in the

United States Senate, and I am not proud of this, that does not

own one stock, one bond, one debenture, and never has.

I had a stupid idea when I was 29 saying that was an inherent

conflict, and I am inherently poor. It was dumb, so I am not suggesting that I know much about this, about how the system works.

But I will tell you what. When the guys and women who rest upon

making it off of this believe, whether it is true or not, that they

haven’t seen the bottom of this yet and they believe it is systemic—

and I hope I am proven to be wrong, but let me tell you something.

They are voting with their dollars right now, and I will be dumbfounded and overjoyed if six months from now we gather for a reunion and there have been no more Enrons, there have been no
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more WorldComs, there has been no more significant readjustment

of major corporate assets.

Senator SESSIONS. Mr. Chairman, one reason we will probably

see some more is because when things are going well, it is not apparent.

Chairman BIDEN. Exactly.

Senator SESSIONS. It is when things go bad and the prices drop

20 percent and all of a sudden you can’t pay dividends. So I suspect

we may find some more, but I don’t know that it means the entire

financial structure is compromised.

Mr. DONALDSON. If I could add, I think, too, everybody is stripping down to their underwear at this point to prove they have

nothing to hide.

Chairman BIDEN. I agree with that.

Mr. DONALDSON. So we are going to see a little of that for a

while.

Senator SESSIONS. It is healthy.

Mr. DONALDSON. It is systemic, but we will pull out of it.

Chairman BIDEN. I think we will pull out of it.

Mr. DONALDSON. I think the question it will be interesting to ask

is two years from now, will we be able to say the reforms that we

put in place—I don’t know how we got along without them all these

years. That is the way I want that question to be answered.

Senator SESSIONS. Mr. Chairman, I wanted to pursue Mr.

Devine’s whistleblower idea. And, George, maybe you can comment

on this.

We have the qui tam provisions in Federal contracting law,

where a person can reveal a fraud that hurts the Government in

a Government contract, and then a lawsuit can be filed and they

are paid 15 percent of the recovery. You have to have, a person to

report to though.

I had a person come to me when I was in private practice, and

you call the Department of Justice and try to get them to file it.

If they don’t, you can file it yourself.

Should there be within the corporate structure of major corporations a committee that the employees all know that they can take

a complaint and a concern to?

Mr. DEVINE. I think there does need to be—and as the other witnesses have pointed out, there has been a lot of these committees

created. The Achilles heel has been conflict of interest.

Senator SESSIONS. George, you have been a prosecutor. If a person comes into this committee, and at least if they write down the

complaint and everybody on the committee sees this complaint and

says there is nothing to it, and George comes along about two years

later and starts investigating them for criminal fraud and you are

looking to prove knowledge, that puts them in a big hurt, doesn’t

it?

Mr. TERWILLIGER. Yes, it does, and I think in terms of the internal whistleblowing and reporting process, part of what we hear

here from the two ends of the table alongside me are two different

considerations.

One is the concept of whistleblowing and having a place to take

these complaints. Frankly, when companies ask me about that, I

say that is a great idea. Who would you rather have them report
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some alleged fraud or malfeasance to, you or some outside lawyer

who is going to file a lawsuit?

Senator SESSIONS. The FBI.

Mr. TERWILLIGER. Or the FBI, that is right. Giving the company

a chance to deal with it proactively to begin with is a good idea.

What we hear from the other side is whether or not it works the

way it is set up. Is there a compliance process that this goes into,

and does that work well or not? I dare say that every corporation

in America is probably asking itself that very question about its

own internal processes now, which is a good thing to come out of

this.

I would like to just react further for just one second to what the

chairman mentioned before about not seeing the bottom of this yet

and what not. It is far too late in the day to pick a fight with the

chairman, if there is ever a time to do it, and I am not intending

to do that.

But I do think it is important that if there are systemic deficiencies that allow this to happen, that is one thing. That is different than saying that this kind of cheating and this level of dishonesty and disloyalty to corporate duty is systemic in and of itself,

because I don’t think that is true.

I don’t think that most corporations are like those outliers that

we have seen now, and we do a disservice to ourselves and to our

economy and to investors if the perception is that we are generally

vilifying corporations, which I don’t think the chairman intended to

do and I don’t think that is what he was saying.

I do agree that we are in a horrible crisis now, and stock prices

are very low, Mr. Chairman, and maybe if you were ever tempted

to buy, this would be a good time to do it.

Chairman BIDEN. I don’t have enough money to buy now.

Mr. DEVINE. I have a little more to offer in answer to your question, Senator. We have been involved in an experiment for those

types of committees that seek to break through the conflict of interest. It is a form of alternative dispute resolution, a committee sponsored by the company that the whistleblower can go to.

We tried it with the Westinghouse Corporation out at the Hanford nuclear weapons site, a Government contract facility, and the

committee they bring their concerns to has a balanced representation from the board of the company, Government representatives to

observe, and citizens organizations. Something like that could be

adapted to the shareholder institutions, the institutions of a corporation.

If someone raises their issues to that committee, there is a general pledge and consensus that they cannot be retaliated against

for working through that option. It has had a healthy impact; it

has been a real change. It is not a panacea, but it has had very

visible results.

The other suggestion would be going right to the example that

you used to illustrate, the False Claims Act. I think that it is worth

considering adopting that model to a fraud against the shareholders. Right now, it is just fraud against the Government in contracts. This would be a way to slice through the conflict of interest

if whistleblowers had standing to sue on behalf of the shareholders

when there was fraud that threatened their investments.
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Senator SESSIONS. The people here that are victimized are the

shareholders ultimately, and they are trusting to corporate leadership and they are willing to accept bad judgment. The company

tries a new product line and it fails and everyone loses their shirt.

People can accept that, but they are not willing to accept being

cheated, and they shouldn’t.

I do think usually there is somebody in the system who knows

about the problem and should bring it forward if they have a convenient place, and perhaps the qui tam might be a way to do it.

Mr. DONALDSON. Could I just insert one thing?

Senator SESSIONS. Yes.

Mr. DONALDSON. The kinds of deep, almost catastrophic shenanigans that have been revealed recently would be very difficult for

any of the sort of compliance model, information line, hotline, opendoor policies to handle. I just want to make that point.

Senator SESSIONS. But you could have had a——

Mr. DONALDSON. I am not saying we shouldn’t have them and we

shouldn’t try to improve them.

Senator SESSIONS. But do you think there is somebody at, say,

Enron that saw the accounting problems here at an earlier stage

and could have expressed concern to somebody?

Mr. DONALDSON. Absolutely.

Senator SESSIONS. One more thing. Judge Griffin Bell, a former

Attorney General of the United States, discussed a problem with

me when I was Attorney General of Alabama. He was dealing with

a company that may have acted improperly regarding some commercial contracts, retail-type contracts, and they were concerned

about doing the right thing.

You can be sued in any State in America for fraud, and they

want to come forward and they wanted to pay everybody, but they

were terrified they were going to get sued in a big class action and

the whole company would be in danger. I think they eventually

came up with some way to do it, but there is not a real mechanism

in America today for a board to say, wait a minute, we have been

doing this kind of procedure for many years. We have cheated our

customers or they have lost $100 a piece and we are willing to pay

them. But if each one of those people are going to then sue them

for $100 million in every State in America, the whole thing gets

awfully scary.

Should we have some mechanism by which a company can selfreport and pay just compensation, maybe even some penalty in addition, but it wouldn’t turn into a massive litigation frenzy?

Mr. TERWILLIGER. Well, I will respond to that in part, Senator

Sessions, that at least in the first instance on criminal sanctions,

the fact of the matter is that voluntary disclosure programs generally do not work because the incentives for doing so are outweighed by the risks, including the risks of lawsuits, the risks of

being prosecuted.

Senator SESSIONS. Don’t you think the risk of civil litigation is

probably worse than being prosecuted?

Mr. TERWILLIGER. It is at least as bad.

Chairman BIDEN. Not for any corporate executive I know. Give

me a break, give me a break.
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Mr. TERWILLIGER. No, no. I think, Senator, we are talking about

the corporation itself.

Chairman BIDEN. I got that. I have found, though, at the end of

the day they don’t sit there and think, oh, my God, the corporation.

They are sitting there saying, oh, my God, me.

Mr. TERWILLIGER. That is a good point. Again, I think that is

why some other types of alternatives to affect the corporate behavior of managers is important. God help me if I wind up representing one of these people on this kind of an issue, but I think the

idea of expanding the sanction of banning someone from serving in

a position of corporate responsibility in a publicly-held company is

a very good incentive because a lot of people think that the risk of

engaging in dishonest behavior is worth it. Even if they wind up

paying some kind of a price for that act, they believe they will get

back in the game. If what they are talking about doing is giving

up a career completely, I think that helps to change the equation.

Senator SESSIONS. The example I am giving is if self-reporting an

action that might be marginally criminal, the person might feel like

they are really not going to be prosecuted if they go to the prosecutor, the U.S. Attorney, and lay it all out and say they have got a

plan for correction. Maybe it is a regional manager for the western

United States that has been doing a contract in a satellite dish

deal and they found out the way they are doing it is wrong.

Mr. TERWILLIGER. It would probably be procedurally difficult to

insulate them from civil liability, but it certainly might be a way

to avoid punitive damages, mitigate damages in a case.

Senator SESSIONS. Judge Bell feels very strongly about it and

probably would write us his opinion on it.

Chairman BIDEN. Let me proceed along these lines just a little

while, and we realize we are really trespassing on your time, but

it is seldom we have this much fire power here to help us out.

If you take a look at WorldCom, they now say that 40 percent

of its investment last year was really operating expense. Now, I understand that cooking of the books is fairly simple trickery, but the

company just simply stated that routine operating expenses were

capital investments, which had the effect of inflating the profits extraordinarily.

Now, I am no accountant and I am no expert, but that little

math gimmick strikes me as the kind of basic accounting that students in 101 at the University of Delaware would understand was

inappropriate. Yet, WorldCom’s auditors didn’t catch it. Arthur Andersen, which reportedly was paid $4.4 million to certify its books,

didn’t detect this seemingly simple trick. The board of directors

didn’t seem to know it.

How could WorldCom fake nearly $4 billion in expenses? How

could the regulators, the auditors, the analysts, the banks have

missed this possibility of corporate fraud? What am I missing here?

Mr. DONALDSON. Classic cases, long Harvard Business Review

type cases, and business ethics for decades have had accounting

fudging, pushing the envelope in accounting, as an issue. But what

we have seen in the last five years is brazen pushing of the envelope, of the WorldCom type.

I think you have just got to face the fact that the climate has

changed. With all the emphasis on short-term stock value, driven
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by some of the Internet shenanigans earlier, and with stocks constantly rising, corporate officers have been willing to make amazing

accommodations with accounting tricks.

Chairman BIDEN. You sound like you are from the State Department.

Mr. TERWILLIGER. Mr. Chairman, I think that the fact of the

matter is—and I am not an accountant and I can’t speak to specific

treatments in specific circumstances. One of the oldest tricks in the

book in accounting and financial reporting fraud is to, in fact, capitalize what should be annualized expenses.

There are rules that govern this. These rules are not necessarily

ironclad principles that reduce proper accounting treatments to

black and white. I have been involved in cases where there have

been great arguments about when inventory can remain valued as

inventory and when it is no longer of any value or not of the

same——

Chairman BIDEN. I got that. I was on the other side of you guys.

I was a public defender, and I still got elected. When someone recklessly endangers another person’s life, they can get convicted of

manslaughter and they can go to jail for a long time. And they

didn’t have to intend to kill anybody. They had to know that this

reckless behavior might result in that happening.

Yet, on the white collar side of the equation, right now the

WorldCom situation—and you guys are former prosecutors—under

current law, the prosecutor has to prove that the defendant actually knew and took part in the fraud, not just was incredibly and

willfully or recklessly negligent.

When I can be convicted of manslaughter for recklessly behaving

if I cost the economy—and I mean talk about driveby shootings.

This has been a driveby shooting. There are a whole heck of a lot

of people who are in real trouble who were no part of WorldCom,

didn’t own any stock in WorldCom, didn’t have anything to do with

WorldCom.

Look, there is a Brazilian company at WorldCom. You know, talk

about this being internationalized, for example, WorldCom’s largest

international subsidiary was a Brazilian long-distance company.

Their stock dropped even after it was absolutely clear that it was

operationally and financially independent of WorldCom. Talk about

a driveby shooting in a country that is already in deep trouble,

whose economic system is in dire straits, and boom.

Should we have a standard in the law that says if you are recklessly negligent?

Mr. TERWILLIGER. Well, we do to a certain extent in the criminal

law of fraud on the Federal level have that standard in the sense

that the legal term is ‘‘conscience avoidance.’’ As a practical matter,

what it means is turning a blind eye, and prosecutors can substitute evidence of turning a blind eye for actual knowledge and obtain convictions of individuals on that basis. So you can’t simply

say ‘‘I don’t see.’’

The concept of recklessness, I think—and again I am not a law

professor, but the concept of recklessness is inconsistent with the

notion of fraud, which is an intentional misrepresentation or concealment.
211

Chairman BIDEN. Well, I would argue it is no more inconsistent

than the notion of murder or manslaughter.

Mr. TERWILLIGER. Well, that may be a legislative judgment,

frankly, Mr. Chairman, to make to make that a crime, but I don’t

think that is fraud as we have known it to date.

Senator SESSIONS. Mr. Chairman, I am kind of interested in that

because you are raising a good point. My observation is when you

talk to the business community and the prosecutorial and law enforcement community, it is like they have entirely different visions

of that animal we are dealing with.

The business community is just terrified. They sign all these documents everyday, the regulations that come in. People around

them are signing documents, just like we do. People sign our

names to things we don’t even read and they are going out all over

the place and they think they are going to be put in jail for it. So

they don’t want to strengthen the power of the Government’s hand.

It terrifies them because they are honest and they think they

might be dragged before the bar.

Chairman BIDEN. A legitimate concern.

Senator SESSIONS. But the truth is we need to focus some way

on criminality here. We talked about it earlier. Maybe the punishments could be less for these kinds of reckless matters.

What do you think, Professor Elson? It is making you nervous,

I can tell.

Mr. ELSON. Well, yes. If the goal here is shareholder protection,

which is the whole point—I have got my retirement monies in

TIAA–CREF, the teacher’s retirement fund. So, you know, I am in

the equity markets as a potential retiree, too.

Chairman BIDEN. If you were in California, you just lost $580

million.

Mr. ELSON. In TIAA–CREF, I just got my statement and I have

lost quite a bit, too.

The bottom line is protecting investors’ money, because if we

don’t in the long run what happens is nobody invests and our

whole system stops. The key to investor protection is confidence in

the markets so people will invest. The question is how do you get

to the goal of preserving company assets and shareholder assets.

What I fear in changing the standard to recklessness is that you

will create avoidance procedures on the part of management, who

will develop all kinds of legal regimes, compliance procedures and

what not, to avoid that kind of prosecution, which in the end I fear

will take the focus off of preventing wrongdoing and instead simply

avoiding liability. That is terrifying to me as an investor and I

think that is the bottom line.

I want management and the board working for the investor, period, and when their goal is taken off of that and focused instead

on avoiding some sort of a liability, then I think you have got a real

problem in the system.

Senator SESSIONS. As a prosecutor, I prosecuted several cases

that I personally tried that dealt with fraud charges that pivoted

around values of properties. And I am telling you it is a difficult

deed to convict somebody on anything when you are dealing with

value. It is like pornography; I know it when I see it. I know this
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property is not worth this much. He loaned two times its value, but

somebody somewhere said it was worth ‘‘x.’’

Oil prospects in Texas was one case we tried. So what is it

worth? It wasn’t worth what they said it was, but it is difficult indeed to prove beyond a reasonable doubt when you have got some

witness to say, well, it could have been worth that much. So my

prosecutorial instinct here is that we have got a lot of people getting off the hook on some things that are difficult to prove.

Chairman BIDEN. I would note that most of the U.S. Attorneys

I have had the privilege of suggesting should be appointed by the

President of the United States over the last three decades and most

of the Attorneys General that I know are not crazy about picking

up these suits. And it is not because they are not good guys. It is

because they are incredibly time-consuming, they are incredibly difficult to prove, they are incredibly complex. And if they have an

ambition to demonstrate that they, in fact, can protect society, they

can pick up three or four murderers in the time they get one of

these major cases through.

Senator SESSIONS. And if it blows up and their case falls apart,

then they are ridden out of town on a rail.

Chairman BIDEN. And most who are appointed and want the jobs

don’t come from the civil side of the equation. They are not the lead

corporate counsel in a large law firm who wants to be a U.S. Attorney. They are usually somebody else.

I won’t keep you much longer, but if the Lord Almighty came

down and sat in the well there and said, okay, you get to have one

reform, one thing that would change in order to sort of reconstruct

the appropriate corporate culture, reconstruct the notion that there

is transparency, reconstruct or elevate competence in the system—

if you only got one, what would you pick, what one thing, Professor

Elson?

Mr. ELSON. Very simply, truly independent, long-term, equityholding boards, period.

Mr. TERWILLIGER. I agree with that.

Mr. DONALDSON. That actually combines a number of items. I

was going to say limitations on the sale of stock acquired by options, but that is part of the issue here.

Mr. DEVINE. Predictably, my dream would be around whistleblower rights, and since you passed the reprisal protection in the

Senate today, I get to switch to helping them make a difference.

My suggestion would be to apply the False Claims Act model to

whistleblowers who are suing on behalf of the shareholders of the

corporation.

I would point you to the track record with Government contracts.

In 1985, the last year before the False Claims Act was modernized,

the Civil Division of the Justice Department collected $26 million

in civil fraud recoveries. That increased exponentially the first decade after the False Claims Act was passed to average about $200

million a year. Last year, in one suit alone, the Justice Department

collected over $850 million. This is a highly effective remedy if the

internal reforms of more reliable boards aren’t sufficient.

Chairman BIDEN. Did we do the right thing, and does it matter,

in the elimination of joint and several liability in security fraud

cases?
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You get a dispensation, Mr. Terwilliger. You need not answer

that.

Mr. TERWILLIGER. Thank you, sir.

Chairman BIDEN. What do you think? Did we do the right thing?

Mr. ELSON. I believe so. I supported the reform.

Chairman BIDEN. I am just taking that one provision. I am not

talking about the whole thing. You have outside accounting firms

saying the inside accounting operation should have known it. The

company goes bankrupt. The thing that is left is the accounting

firm, although that is not the case now. Well, think about that one.

From my perspective—and I will end with this and anybody who

wants to comment on it, you are welcome to. What we will do is

rather than keep you longer, I have several questions to ask each

of you in writing, if I may. I have kept you here until 7:30 almost.

From my perspective—and I have a lot more to learn here and

I would rather make no law than bad law right now—it seems to

me there are multiple pieces to what has evolved in a culture that

is not merely a corporate culture, but a culture that we have seen

sort of the aberrations in the dot.com—I mean, this notion that we

are global, we are interconnected, everything is in a moment, everything requires immediate gratification and impact for your

stockholders, for your investors.

It seems to me we have to address four or five things, and I don’t

know the answer to each of them, but I am going to ask you to

think about this. If you want to comment now, fine. If not, I would

appreciate it for the record.

One is we have spurned the OECD initiative regarding the tax

shelters offshore. It seems that we have incentivized people to do

things that don’t make any sense. We have to do something relative to the notion of how we deal with stock options. You folks

have spoken about that.

Thirdly, we have to have what the Sarbanes legislation primarily

focuses on. We have to deal with the whole notion of transparency,

accountability, responsibility of accounting firms, separating accounting and consulting, and disincentivizing people from doing

things on hard decisions they have to make.

We have to deal with the criminal penalties side, which this committee is focusing on, and we have to at least go back and look at

the private sector, the legal community, the stockholders’ availability to initiate on their own civil suits that have nothing to do with

government involvement at all; at least go back and examine

whether what we have done was, in fact—did we go too far, or did

it have no impact on part of what is happening now? Lastly, unrelated in a direct sense, we have to figure out federally how to deal

with the whole notion of pension protection in ways we haven’t addressed yet.

So I want to make it clear to you I don’t think there is any one

answer, and I want to make it clear to you how much I appreciate

the fact you have just been sort of brainstorming with us here. If

I had all the answers, I would be the first to tell you I thought I

did, but I don’t.

Mr. DONALDSON. Senator Biden, can I interrupt and add just one

item to your list?

Chairman BIDEN. Please.
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Mr. DONALDSON. I am resistant to legislation in this area, if

there is any other way of handling it, but I do think the issue of

the relationship between investment banks and analysts is part of

this whole cultural issue.

I will never forget being in front of dot.com presidents about a

year-and-a-half ago, about 300 of them, asking them if a person

came to you from a large investment bank and said, sotto voce, you

know, we can ensure that your stock will be valued high, but we

do want you to do your investment banking with us, how many of

you would do it? Ninety percent of the people in the room raised

their hands. Then, of course, they turned and said but it is their

responsibility in the investment banks, not ours.

Chairman BIDEN. I agree, and I mentioned that at the beginning

of this hearing because there is such a symbiotic relationship there.

A 60-second digression here. When every foreign, newly-emerging

democracy comes to me and to the Senator and others and says,

help us with our constitution, talk to us about it, what is the most

significant thing that your Founding Fathers had—they are looking

for little nuggets, and I say the most significant thing about our

Founding Fathers was they took human nature as it was, not as

they wished it to be, and they wrote it in; they wrote it that way.

I realize they should step up and they should do the right thing,

but the idea that if I go to xyz investment banking company and

they get a piece of the action and they are the ones who are going

to rate me and they are the ones who are going to sell me—and

the ability of the human mind to rationalize should never be underestimated.

At any rate, I would like to put into the record Senator Leahy

and Senator Hatch’s statement. So I ask unanimous consent to do

that.

Chairman BIDEN. I will leave, as is appropriate, the closing questions or comments to my friend from Alabama, and if he has none,

invite any of you to make any closing comment at all on anything

at all.

Senator SESSIONS. I would just say, Mr. Chairman, that I won’t

go into it now, but I think Mr. Terwilliger understands that the

SEC really is where a lot of this stuff is first identified, and the

relationship between the SEC and the Department of Justice and

the prosecutors and/or the FBI sometimes is really important to enhancing the identification of actual fraud.

I truly believe that if a whistleblower comes forward with a complaint today, every board in America is going to pay a lot more attention than they would have six months ago. So it is a painful catharsis we are going through here, but I believe the net result is

going to be more integrity in our financial markets and more integrity in corporate leadership.

The American people are angry and they are losing money. The

best thing about the American democracy is there is nothing better.

Chairman BIDEN. Well, I wouldn’t agree with you more. One of

the reasons you have got folks like McCain and others calling for

Mr. Pitts’ resignation is because he has the SEC, Securities and

Exchange Commission, and he was one of the main arguers against

the stock exchanges changing some of the regulations you call for

here.
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You know, the President called for a corporate fraud task force.

The thing I want you to think about is what about basically a

shareholders fraud task force and people leading that?

Again, I can’t tell you how much I appreciate it. If any of you

have a closing comment, I would be happy to hear it.

Mr. TERWILLIGER. Mr. Chairman, I just want to say thank you

for the opportunity to be here with you and Senator Sessions and

your colleagues to talk about these very important issues. I am

honored to be here.

Chairman BIDEN. Well, I thank you all. We are truly honored to

have such a distinguished panel. I will warn you, we may call on

your later. I like to think we are out of the woods and we know

what we are doing, but I am not sure we do yet, and so we may

need some additional help.

I will have some questions, and I will leave the record open for

other Senators to submit questions. I don’t want to overburden you.

I know you are all busy, but we would like to ask some questions

that we didn’t ask tonight.

With that, I again thank you for your indulgence.

Thank you for being here. We are adjourned. [Whereupon, at

7:33 p.m., the subcommittee was adjourned.]

[Submissions for the record follow.]

[Additional material is being retained in the Committee files.]
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(273)

ENSURING CORPORATE RESPONSIBILITY:

USING CRIMINAL SANCTIONS TO DETER

WRONGDOING

WEDNESDAY, JULY 24, 2002

UNITED STATES SENATE,

SUBCOMMITTEE ON CRIME AND DRUGS,

COMMITTEE ON THE JUDICIARY,

Washington, D.C.

The subcommittee met, pursuant to notice, at 2:39 p.m., in room

SD–226, Dirksen Senate Office Building, Hon. Joseph R. Biden, Jr.,

Chairman of the Subcommittee, presiding.

Present: Senator Biden.

OPENING STATEMENT OF HON. JOSEPH R. BIDEN, JR., A U.S.

SENATOR FROM THE STATE OF DELAWARE

Chairman BIDEN. I want to thank you for being here, number

one. Number two, I apologize for being a few minutes late. We just

got finished voting on an issue and some of my colleagues will be

coming in late. I have a relatively brief opening statement, after

which I will turn to our witnesses.

I would like to welcome you all to the third in a series of hearings I am holding on white collar crime and the adequacy, or shall

I say the inadequacy of penalties for white collar offenses.

Way before the truly mind-boggling events of WorldCom, we

were exploring this question of corporate responsibility and the extent to which so called white collar crime offenders should be held

accountable in the criminal justice system. Embarrassingly, it is a

question that has for years evaded this body, the courts, and the

overall criminal justice system.

I say embarrassingly because the answer to the question strikes

me as painfully obvious. Of course, white collar criminals should be

treated as harshly under the law as petty thieves or drug dealers.

Yet, our policy prescriptions have been muddled. Indeed, the institutions that oversee crime policy, including the U.S. Congress, have

been a bit schizophrenic on this issue.

I have been deeply troubled, as all of us have been, by recent

events in corporate America. Even more disturbing has been the

impact these scandals have had on investor confidence and this

country’s economic well-being, at least for the moment.

In concert with an already sagging economy, allegations of corporate malfeasance have resulted in plummeting stock prices, a

drop in consumer confidence and consumer spending, and rising

unemployment in an otherwise stable economy. With about 60 per-
274

cent of all American households invested in the stock market, we

have become a nation of investors, and if we are unable to preserve

investors’ confidence, the markets will continue to plunge, and with

them the health of our economy.

Today, we will address these questions in light of Congress’ ongoing effort to pass accounting reform legislation and the real-world

spiral we are now witnessing. There are three things I think we

have to do immediately: first, toughen in a rational way criminal

penalties. As I mentioned, Senator Hatch and I secured passage of

a bipartisan amendment that passed without a dissenting vote in

the Sarbanes accounting bill that would enhance the underlying

criminal penalties for fraud, for conspiracies to commit certain

white collar crimes, and for violations of pension protection measures.

Most significantly, our amendment also includes a provision that

imposes criminal penalties on top corporate officials who lie about

their company’s financial health. Should we expect anything less

than accurate financial statements from corporate officials?

Let me be clear. The legislation we passed and is being mulled

around in conference now would not hold any corporate executive

or chairman of the board liable for negligence. It would only hold

them liable if it were proven beyond a reasonable doubt in a court

of law that they knowingly and/or willfully misled the SEC.

That is why Federal Reserve Board Chairman Alan Greenspan

last week testified before the Senate Banking Committee that imposing criminal sanctions on CEOs who knowingly misrepresent

the financial health of their companies is the key to real reform in

corporate wrongdoing.

The second thing we must do is insist on more transparency. I

won’t belabor the point, given our recent and extensive debate on

accounting reform, but suffice it to say that we need truth in auditing and truth in accounting. Top executives must be compelled to

provide investors with clear, accurate financial information. If they

don’t, they should be held accountable. And if they don’t and they

are not confident of it, investors might as well go play the lottery

as invest in stock.

The third and final thing we need to do is enable citizen suits.

I may be in the minority on this view. I was one of a handful of

Senators to vote against the so-called Private Securities Litigation

Reform Act of 1995, which was ultimately enacted over President

Clinton’s veto. I opposed this anti-investor bill because it severely

restricts the ability of defrauded investors to recover their hardearned dollars.

What we are seeing today in the form of corporate abuse, in my

view, is the quintessential chicken coming home to roost. I know

I won’t win many friends by saying this, but we are beginning to

see the true consequences of this anti-investor provision included

in the 1996 legislation. And if we are serious about ensuring corporate responsibility, we need to make sure that defrauded investors are able to bring legitimate suits to hold corporate wrongdoers

accountable and to recover their losses.

Finally, I believe that in the accounting reform legislation, which

is in the House–Senate conference this week as we speak and includes the bipartisan Biden–Hatch amendment, it is important to
275

step up to these problems. I hope we will soon get a bill that preserves fundamental reform initiatives and invites the President’s

signature.

We have assembled here today a truly blue ribbon panel of witnesses. I am not suggesting by my opening statement that they

agree with anything that I had to say, but they will have their own

opening statements and I am eager to hear our witnesses.

G. William Miller is the chairman of the merchant banking firm

of G. William Miller and Company. He has a wealth of experience

both in government and in business. Mr. Miller was Chairman of

the Federal Reserve Board from 1978 to 1979.

That is when I first met you, Mr. Chairman.

He served as Treasury Secretary under President Carter from

1979 to 1981. Secretary Miller is also a businessman who rose

through the ranks of Textron to become the Chairman and CEO,

and now runs his own company. We look very much forward to his

statement.

I would also like to welcome Roderick M. Hills, another distinguished member of our panel. He was Counsel to the President and

Chairman of the Securities and Exchange Commission under President Ford, who, by the way, is one of the finest guys I ever served

with. He currently serves on the board of directors of three corporations. In addition, Mr. Hills has served on the boards of 16 corporations. In 13 of those positions, he was a member of the audit committee, responsible for ensuring that no one was cooking the books.

We look forward to hearing his comments.

Mr. JAMES R. Doty is a partner in the law firm of Baker Botts,

LLP, and is head of the corporate and securities practice there. He

was a former General Counsel of the Securities and Exchange

Commission between May of 1990 and December of 1992. He is a

graduate of Yale School Law, which is the only thing I hold against

him, and has written a number of articles regarding securities legislation. We are glad to have him here.

My son is a graduate of Yale Law School and I point out to him,

having graduated from Syracuse Law School, that he really didn’t

attend a law school. It happens to be the number one rated law

school in America, but we refuse to acknowledge that in my household.

Mr. DOTY. Many people agree with you, Senator.

Chairman BIDEN. His brother went to Syracuse, as well, but my

son responds that it takes two Syracuse law degrees to equal one

Yale law degree. So I don’t know what the story is here.

I thank you all for being here, gentlemen, and I can’t tell you

how much I am looking forward to your testimony because of the

wealth of experience you all bring to the table.

Maybe, Mr. Secretary, if we could begin in the order that you

were called, I would welcome your comments and then maybe we

can have a discussion.

Secretary Miller?
276

STATEMENT OF G. WILLIAM MILLER, FORMER SECRETARY OF

THE TREASURY, FORMER CHAIRMAN OF THE FEDERAL RESERVE BOARD, AND CHAIRMAN, G. WILLIAM MILLER AND

COMPANY, WASHINGTON, D.C.

Mr. MILLER. Mr. Chairman, thank you very much. It is a pleasure to be here and I appreciate the opportunity to comment because the subject that you are addressing is obviously enormously

important to our economy and to the well-being of the American

people.

Momentous events have occurred in the last year. 9/11 certainly

exposed us to a foreign threat of unprecedented magnitude and unknown sources of danger to our country. But the parallel threat

from what is happening through the breakdown in corporate accountability and responsibility is equally a threat, a domestic

threat to our well-being.

There have been corporate and business crises before. This, of

course, is of unusual magnitude, not in just the number of companies that have been in trouble, but also the amount of values that

have been destroyed. Not only have the savings and hopes of the

employees and families of these companies been impacted, but the

loss of capital values since Enron announced bankruptcy has exceeded the gross national product of any country in the world other

than the United States.

Chairman BIDEN. I never thought of it in those terms. That is

kind of staggering when you think of it in those terms.

Mr. MILLER. It is an amazing destruction of values that has occurred. And while, yes, we have had difficulties in the past, that

is certainly something that brings the issue home and focuses our

minds, all of us, on the importance of seeing why this has happened and how we can assure that it will never happens again.

It is not possible to legislate honesty, but any civilized society

will want to have rules of law that deter criminal activity and protect society against dishonesty that can have even minor impacts,

not to mention the huge impacts that we have seen recently.

I just want to note, however, that my testimony is not based on

my experience in criminal law, in which I have little experience.

My testimony is based upon my corporate management experience

and my Government experience, and it is in that context that I

would like to give you my thoughts.

The Federal Government’s response to this crisis has been remarkably swift and comprehensive. Even a few months ago it was

very much doubted that the Congress could act so quickly to bring

into control a situation that seemed to demand action. The fact

that the House and the Senate could pass comprehensive legislation so quickly is quite impressive.

I understand that the conference committee on the two bills was

able to reach agreement today, so we will soon see what the structure of the final proposals will look like. We not only have the congressional action, but, of course, the SEC has responded with its

own proposals and the President has put forth his plan.

Your subcommittee has had a good deal of testimony about the

nature and the characteristics of white collar crime. So I don’t want

to dwell too much on it, but it is an area that has its own degree

of difficulties.
277

Quite often, white collar crimes are committed by people of

above-average education and above-average intelligence who stand

in legitimate roles in society and have the capacity to use deception

and stealth to carry out their plans with remarkable effectiveness.

It is hard to ferret them out, and it is hard often to prosecute them

because they can obscure the facts so easily.

As a consequence, this inherent charactristic makes it very difficult to know how to apply the deterrent effect that you are seeking through your amendment to be sure that corporate responsibility is assured.

Financial accounting, which has been the root of much of this

problem, is a field that involves many estimates and judgment. As

a result, it offers an opportunity to disguise misrepresentation because there are so many elements that can be hard to understand

or to comprehend.

Corporate structures also are becoming very complex. Most companies now are not confined to a single-product line. They have

multi-product lines. They have operations in many areas. They

have global facilities. They have transactions in foreign currencies.

They operate under different business ethics in different parts of

the world. So it is very easy, if there is a desire to misrepresent,

to obscure and hide. So it is a very difficult task to identify and

assess blame.

So it makes sense that your subcommittee and the Congress and

the Government should be focusing on how to have maximum emphasis on deterring the crime before it is committed rather than

trying to penetrate this very difficult system.

The question is how can you use criminal sanctions to deter the

wrongdoing. How do you establish a system of punishment and a

belief not only that a crime will be detected, but also that there will

be swift and effective punishment? How do you make the punishment fit the crime?

In the white collar area, and certainly in the corporate area,

there probably has been a sense that detection was not likely and

that if detection were made that the threat of punishment was limited and might even be nominal.

So there is going to be success in creating deterrence through

criminal sanctions only if there is a belief by potential white collar

criminals that there is a high likelihood of detection and a high

probability that, if detected, there will be serious punishment.

The most powerful deterrent in this field, as in many, is jail

time. That is a threat that people understand. For business criminals, money is also important, but there is nothing that is more effective than the expectation of spending time in prison.

There has been some progress recently in strengthening the

criminal sanctions for white collar crimes, and the Biden–Hatch

amendment that you have proposed goes further in trying to accomplish that to strengthen and to introduce an element of accountability through requiring the certification of corporate reports.

With respect to the criminal penalties that have been proposed

in the amendment, I find them to be rather rational and appropriate. They seem to be harmonizing, and as you have pointed out,

they are trying to make the criminal sanctions for white collar
278

crimes comparable to the sanctions that would apply to other kinds

of crime. In that respect, I think the amendment is right on target.

The other element of the amendment, the concept of requiring

certification by the senior officers of the financial statements, is

one that is being widely discussed. It is clear from what has happened that there may have been a breakdown in accountability for

corporate misrepresentation and wrongdoing.

While I would have thought that deliberately misrepresenting financial statements would already be a criminal offense, the amendment makes it explicitly so, and therefore strengthens and focuses

clearly on this element of white collar crime. The number of meltdowns makes it clear that accountability needs to be in place, and

the idea of getting these certificates is one way to get the hook on

for accountability and to assign specific responsibility with a serious sanction for violation.

The proposal is logical in that sense, but as I understand it, it

recognizes that senior officers—CEOs, CFOs, chairmen—cannot

personally audit the books of a complex company. There is no way

they can do that. Thousands and thousands of hours are spent auditing a complex company.

So one would expect that the intent of this particular requirement would be that these officers exercise due diligence, that they

make proper investigation, they hire honest people, they supervise

them properly, and they involve themselves in making sure that

procedures are in place to assure that the statements are correct.

And I assume that is the context in which this is presented. In that

sense, I believe that the proposal will be a positive contribution to

increasing the deterrent effect of the criminal justice system on

these misbehaviors.

A couple of comments I would make, however. One is that the

amendment specifically calls out three officers or their equivalent.

There are many companies that have chairmen who are non-executive. My personal experience is that non-executive chairmen do not

have the time or the responsibility to have the intimate knowledge

of a company that a full-time executive would have.

It would seem to me you might want to limit this to people who

are really full-time executives—the CEO, obviously; the CFO, obviously. If the chairman is, in fact, a full-time officer, yes, but that

element might be reconsidered.

Also, I would imagine, as you pointed out, that in the criminal

system what is needed is to be sure that we do not make it criminal to have inadvertent error, so that it would be a case where

criminality here would relate to deliberate or intentional or knowing misrepresentation, which I believe should already be a crime.

But it is better if this is spelled out very specifically.

When it comes to sanctions, I believe that no amount of potential

criminal punishment will be effective as a deterrent if the perpetrator believes that punishment will never be applied. Therefore, one

might conclude has to say that having sanctions is not enough. One

must have the will, the commitment, and the resources to prosecute and to convict. Without that, the deterrent effect is not there.

I want to point out a lesson from history that I think demonstrates this. It seemed to me that early in my business career

that there was somewhat a loose attitude toward enforcement of
279

the antitrust laws, until some senior executives of a major company

were sent to jail. As soon as they were sent to jail, the whole attitude about enforcing antitrust laws changed.

In other words, it wasn’t the law that changed. What changed

was the enforcement, and when the enforcement changed so that

executives understood that they could end up in prison, suddenly

all corporations adopted antitrust compliance into their ethics

standards. They started holding seminars. Their attorneys were required to educate their people.

So it is important here not only to see that we have sanctions,

but to see that the law enforcement agencies, the SEC and the Department of Justice, have the resources to follow up and enforce.

The impression has been that the SEC has been underfunded in

this, and it is encouraging to see that Congress is addressing this

and is beginning to increase the human and financial resources

that are needed to follow up and to create a real belief that the

sanctions are not simply passive, but they are ones that will be enforced and will create a threat to the personal well-being of the perpetrator.

Let me conclude just briefly by saying that in this particular

kind of crisis we should not forget that, as bad as the situation is,

the great majority of American businesses are managed responsibly

and they contribute enormously to the economic system that has

created in the United States the most prosperous society in the history of the world.

As we look to increase sanctions and increase enforcement, we

must not also add to the discouragement of the business community to attract talent and to attract the skills they need to continue

this process. We must not create a situation in which being a business executive is so onerous that only people who are incompetent

or inclined to criminality are the ones who are interested.

We must continue to create a system that has flexibility and resilience. There must be responsible accounting, obviously. The safeguards, the supervision, and everything must be in place to create

deterrents and to enforce them. But we should also continue to encourage the enormous innovation and creativity of our system.

Even the number of meltdowns we have had in this particular

series of events has not been able to stop the dynamics of our economy. Isn’t that remarkable? With all of these things that we read

about, the billions of dollars involved, the economy is performing

well. The economy is growing. Profits will rise. The stock market

will recover. We have amazing resilience and we shouldn’t talk ourselves into bad times because a few people have upset the apple

cart.

We must remember that when the market was rising, there was

the view that the wealth effect helped the economy. I hope we don’t

talk ourselves into a situation where a declining stock market, because of reasons unrelated to the real economy, has a poverty effect

which depresses the economy. That would be unfortunate, because

this country is really a remarkable example of what can happen

with the right standards and the right atmosphere to release

human talent.

This country is not broken. So as amendments, are enacted it

will be prudent to make sure that the amendments where they are
280

needed and where will be effective to deter and sanction the criminal actions of a relative few people. While the actions of those few

people may have been severe, the great majority continue to be responsible and positive.

[The prepared statement of Mr. Miller appears as a submission

for the record.]

Chairman BIDEN. Thank you very much, Mr. Secretary.

Mr. Hills?

STATEMENT OF RODERICK M. HILLS, FORMER CHAIRMAN OF

THE SECURITIES AND EXCHANGE COMMISSION, AND CHAIRMAN, HILLS ENTERPRISES LIMITED, WASHINGTON, D.C.

Mr. HILLS. Mr. Chairman, in this turmoil that we have surrounding misbehavior by corporations, I hope we won’t lose sight

of the fact that in the past 26 years enormous progress has been

made in corporate governance.

In 1976, because some 400 American companies had been found

to have bribed foreign officials, the SEC persuaded the New York

Stock Exchange to create independent audit committees, required

the accountants to have higher auditing standards, and required

corporations to have effective internal controls. Since that time, directors’ colleges, conferences, and commissions have been trying to

beat the principles of corporate governance into the heads of directors, accountants, and lawyers, but we have some fundamental

weaknesses.

First, the system is 70 years old. It is creaky. It needs a major

overhaul. Experience tells me that everything 70 years old gets a

little creaky. Audit partners have not been able, and probably will

not be able under this system to resist management pressures.

And, third, the audit committees just have not been exercising the

authority that was given them in 1976.

The system: The external audit has become a commodity. Chief

executive officers see no intrinsic value in it. Accountants compete

for the work on cost, not on quality. The system has too many

rules. This maze of rules is an incentive to innovative minds to create these complex systems that wind their way through the maze,

satisfying the rules but frustrating the purposes of our securities

laws.

The auditors are becoming rule-checkers. If the rules seem satisfied to them, they will approve the financial statement even though

common-sense judgment would have directed them to do otherwise.

The quality and the number of people entering the accounting profession has deteriorated substantially in the past 25 years.

The audit committees were created to protect the independence

of the audit and of the auditors, but they are not doing that. They

are not asking the auditors if there is a better way to present the

financial statements. They are not participating meaningfully in

the selection of auditors or in the fee negotiations, and they are not

making any effort for an intensive, independently-assisted evaluation of the work of the auditors. The auditors understand that. As

a result, they don’t expect the audit committees to protect them

from management.

The remedies: There is no secret about where we want to go. Professor Weil of Chicago said, I want accountants to use fundamental
281

concepts in choosing accounting methods. That is the European–

English system. Why aren’t we there? It is because the auditors are

afraid of having their broad judgment tested in juries across the

country and so they ask for specific rules to protect them from that

type of litigation.

The SEC could provide a veneer of protection for them, but I

must say that it would be unwise for them to do so until there is

an oversight body capable of monitoring the profession. The oversight body in the Senate bill is on the right track. Its efficacy is

going to depend upon its ability to work harmoniously with the

SEC. I trust and hope that the conference report today will have

clarified the ability to establish that relationship in a workable

fashion.

The body could be given further authority. It could be empowered

to do more preventative work to find the bad accounting before it

hurts the shareholders. A model could very well be the work of the

bank examiners for the Federal Reserve Board, for the Comptroller

of the Currency, or even the work the SEC does with broker-dealers.

The prescriptions of the Senate bill, I think, also deserve support.

I hope, again, in the conference committee the audit committees,

with effective findings of fact, will be able to give a little more flexibility to some consulting work and a little more flexibility to do

some internal audit work from the external auditors.

The audit committees can fix themselves. They may need a push

from the SEC or from Congress to do so, but they can and must

take charge of the audit. They must, and can, confer the independence that is needed for the auditors. The audit partners are not

going to yield to management pressure if they feel they can be protected, and the point I am trying to make is they don’t feel that

way today.

I do believe that the strengthening of the laws, represented by

the White Collar Penalty Enforcement Act, is positive. It will have

a salutary effect, and as Secretary Miller has said, the real problem

is the difficulty of seeking convictions in financial fraud cases.

The task force created between the Justice Department and the

SEC can be effective. Joint units working with the SEC at U.S. Attorneys’ offices, particularly here in Washington, D.C., can enforce

each other’s ability for their own enforcement responsibilities. The

Justice Department can also at this particular time provide assistance to the SEC because it is going to take the Commission a long

time to train the people they need for the responsibilities they

should exercise.

The biggest hope, Mr. Chairman, for more effective enforcement

of crime will be the budget increases of the SEC and the oversight

body that will come out of this. Working with the Justice Department, they can move faster to deal with bad accounting. And by

moving faster, they can preserve evidence that is otherwise lost,

evidence that can be used later in enforcement proceedings where

it is appropriate.

Finally, as we acknowledge the deficiencies in the system and

begin to correct them with legislation and by practice, it seems to

me we must also acknowledge the importance of the accounting

profession to the global economy and to our society. The profession
282

is in trouble not just because of carelessness. It does not have the

quality of people and the responsibility it needs, and so I suggest

that it is important to not needlessly harm the profession as we go

forward in the task of remedying this system.

I appreciate the opportunity to present those views.

[The prepared statement of Mr. Hills appears as a submission for

the record.]

Chairman BIDEN. Thank you very much.

Mr. Doty?

STATEMENT OF JAMES R. DOTY, FORMER GENERAL COUNSEL,

SECURITIES AND EXCHANGE COMMISSION, AND PARTNER,

BAKER BOTTS, LLP, WASHINGTON, D.C.

Mr. DOTY. Mr. Chairman, I appreciate the opportunity to appear

in this historic series of hearings on white collar crime and the relationship to the current economic and corporate crisis we face.

Sitting here thinking about your remarks on the Yale Law

School, I have to tell you that when I was there one of the professors who was highly regarded said the trouble with this place is

that you, meaning the students, are all young fogies, and we,

meaning the faculty, are all old turks, aging turks. So I hope I can

give you some testimony today that will at least not be either an

old fogy or a young turk.

Your deterrence issue is timely. The current crisis has been cast

against this backdrop of September 11, the end of an historic bull

market, the pressures on management to meet short-term targets

that are intensified by stock option and stock bonus incentives, and

the techniques that consultants have developed to try to boost

short-term values. Those are all circumstances that are getting

properly the attention of lawmakers and regulators.

But what puts the deterrence issue in the forefront is not just

the magnitude of the market loss, but the apparent fact that in a

few of the most conspicuous cases top management acted either

with the belief that they had the informed approval of their boards

and their audit committees or without any serious concern that

they would be called to account.

I think that in common with the themes of my fellow panelists,

deterrence here depends upon two factors. One is increasing the

risk of detection of fraud; second, enhancing the governance mechanisms that act as a guard rail and keep management well clear of

fraud.

In corporate America, as I think my colleagues have said, we

don’t want to have management that is close to the border of fraud.

We don’t want the perception that our people operate close to or

in fear of criminal prosecution, but well short of that guard rail.

As a practicing securities lawyer who advises boards and committees, and as a former General Counsel of the SEC, I share your

concern that corporate America not only act responsibly, but clearly

be seen to act responsibly, and that involves changes, I think, in

our system of corporate governance that are now underway.

I would like to touch on some of the aspects of the criminal side

and then some of the governance areas that I think relate to what

you are doing in this committee.
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First, the hearing, as I understand it, is concerned in part,

among other things, with the question of whether the U.S. Securities and Exchange Commission should have criminal enforcement

powers. That is a real issue, whether Congress should enlarge the

SEC’s statutory mandate to include the responsibility of seeking indictments and prosecuting criminal cases.

We know that violations of the Federal securities laws which are

committed with the requisite intent are now criminal, and indeed

the arrest of the Rigas family in the Adelphia scandal today is evidence of that. the SEC now refers criminal conduct to the Department of Justice, and I just say we have observed no reluctance on

the part of U.S. Attorneys to pursue those referrals.

In those cases, the SEC staff officers who have investigated a

civil fraud case are designated as special assistant U.S. attorneys

by judicial order to assist in the preparation and trial of the criminal case. So that perhaps leads to the fair question, why not just

take the next step and give the SEC criminal authority? I would

like to respectfully warn against that and suggest reasons why I

think the SEC’s authority should stick with the civil and the structure of civil and criminal demarkation be as it is now.

First, civil trial lawyers really are generally not competent to try

criminal cases, and I think they recognize that and I think the SEC

civil enforcement staff would say it is true. That means you have

to create a separate criminal trial unit within the SEC, and that

would be done at a time when the agency is experiencing resource

constraints. Once created, that unit may actually impair, I think,

the close cooperation that now exists between the U.S. Attorney

and the SEC, and which Chairman Hills has referred to.

Second, the SEC has functioned well in the past because of its

limited mission. It has been often said that they have a limited

mandate; that is, to assure transparency in the markets and preserve market integrity through rulemaking, disclosure, and civil

enforcement. If criminal enforcement is added, Mr. Chairman, I

think there is a danger of mission creep. I think the question then

arises as to whether or not violations of the CFTC and the FTC are

also part of that mission.

Finally—and this is, I think, of great concern to the bar that is

on the good side of this exercise of trying to obtain compliance—

I think the civil enforcement process encourages settlement and,

with that, administrative and judicial economy. I think that facility

of settlement is something which past general counsels other than

myself have noted, and would be impaired if the agency had criminal enforcement powers.

So it seems to me the choice for us is to increase the risk of detection of fraud by those committing it by giving greater resources

to the agency for its detection function. I think given the choice between having adequate staff to properly review filings, review accounting policies and practices, investigate initiatives to cover

fraud, all in the early stages which leads to early detection, or, on

the other hand, launching a criminal division within the agency, I

think the agency would prefer to have those resources and, as

Chairman Hills’ comments indicate, go after fraud in the early

stages and be ahead of the wave, ahead of the curve, on where

fraudulent practices are beginning to creep into accounting.
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Now, does the threshold for criminal liability need to be lowered?

I think you have heard persuasive arguments as to why the penalties need to be real. I believe that is true, but I would not tinker

with the threshold for criminal liability because we have to remember it is an economy that we are regulating.

This conduct that we are regulating is often not malum in se. It

is conduct which, if it strays far enough from the complex rules

that we expect to be obeyed, can become criminal. The complexity

of the rules can be part of the problem, but we need to stick with

specific intent. And you, I think, reflected this in your introductory

remarks to us. The object is to keep corporate managers careful,

not render them paralytic.

The standards of criminal liability, I think, also are fairly well

hard-wired into our culture. I think judges, lawyers, and regulators

understand what specific intent is, and I think we understand

what separates it from negligence or even from recklessness that

should involve civil liability.

But none of that implies that we have to rely on just the moral

imperative in the mind of the executive, and I would like to touch

with you briefly on what I think the three changes are that are occurring in our corporate life that relate to the work of the committee, relate to what you have heard today, and I think are going to

transform governance.

First, there is a recognition that corporate accountability and responsibility starts with individual accountability. Just as tone from

the top communicates corporate values and creates corporate culture, accountability starts as an individual matter from the top. We

are already seeing the effects on accountability of the SEC’s June

27 order requiring written statements under oath certifying by

chief executive officers as to the material completeness of financial

statements. I would say, Mr. Chairman, from where I sit there are

few expressions of outrage or surprise. You don’t have people saying why are they doing this. I think corporate America understands

why this must be done.

There are some questions about authority issues, whether the

Commission has authority to continue this as a practice. And that

is in your lap and I think you and your colleagues are attending

to that. But to pick up with where Mr. Miller was leading, I think

processes are in effect. Processes to comply with these certification

requirements and to assure accuracy are well along.

Elaborate processes are communicated down from the top. Companies are getting ready on the 15th of August to make the first

round of certifications, and I can assure you that it has not gone

unnoticed by CFOs and CEOs that these statements, as sworn, are

subject to penalties of perjury.

Chairman BIDEN. Mr. Johnson in 18th century England said

there is nothing to focus one’s attention like a hanging.

And you remember, Mr. Hills, when we went through that. I was

here at the time we dealt with the issue of bribery of foreign governments, and I remember how Irv Shapiro of the DuPont Company got positively involved, and it really did change the focus a

little bit.

I didn’t mean to interrupt you.
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Mr. DOTY. You are right on, and I think corporate America is

ready to do this. It is getting ready to do it and to show that they

have done it right, because they have the overriding interest that

Mr. Miller referred to in having this confidence restored.

The second point is I think the SEC is going to get the administrative authority to bar offenders from serving as officers and directors. I would say this is as great a threat to the reputations, the

careers, and the livelihoods of professional managers as the threat

of criminal prosecution.

Incarceration carries a different threat which Mr. Miller has

pointed to, but I do believe that because this bar will be enforced

administratively and without the independent determination of an

Article III judge, as has heretofore been the case, this is being

taken very seriously. I think it may be the greatest single deterrent

weapon in the SEC’s arsenal going forward.

Third, just to pick up on what Chairman Hills is saying, I think

independence from professional management in the form of independent boards, independent audit committees, and independent

oversight of the accounting profession is essential.

There are some good things going on that I would point out. The

New York Stock Exchange and the NASDAQ rules are going in the

right direction. The New York Stock Exchange is going to give the

audit committee sole responsibility for hiring and firing the independent auditor and the right to approve the rendering of any nonaudit services. These rules will have an effect on the way audit

committees function.

Audit committees read the paper. They are like the Supreme

Court, and I think the current climate has invigorated audit committees. The passivity and the cozy relationship that Mr. Hills and

others have spoken out against over the years, I think, is coming

to an end. Along with the real powers they are getting as an audit

committee, I think you can look to see compensation committees

exhibit more activism and more real oversight of boards of directors.

The accounting profession, with the adoption of the legislation

that has been agreed on today, is going to have either a public accountability board or a public company accounting oversight board,

however you all decide to style it, but it will change the relationship of the auditing community to regulation. Public accountancy

will be a regulated profession, with the auditing practices, the independence, and the standards of each firm subject to annual review

by a body with the independent authority to sanction. The result

of all of that is the recognition of the responsibilities they have is

going to make a big difference.

My testimony is not, Mr. Chairman, that all is well with corporate America, or that criminal sanctions don’t have a part to play

in ensuring responsibility. On the other hand, I do agree with

Chairman Greenspan that we are going to be using this corporate

model that we have for some time. I don’t see us going to a European model. It would not be good for America.

It would be a good exit from this current crisis if our corporate

model and regulatory regime, which have underpinned the most

transparent markets in the world, were once again seen abroad

and at home in that favorable light. I think with the retrospective
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of, say, a couple of quarters in an annual report period, let’s say

mid–May of 2003, the markets may well have concluded that we

once again have the most reliable periodic reports and financial

statements in the world.

[The prepared statement of Mr. Doty appears as a submission for

the record.]

Chairman BIDEN. I thank you all for your statements. With your

permission, I have some questions.

Let me begin by reiterating what most people but the editorial

board of the Wall Street Journal seem to fail to understand. As

chairman of the full committee and chairman of this subcommittee,

I do not believe the answer to our problems lies in criminal sanctions, but I am going to make a relatively broad statement and ask

you each to comment on it, if you would.

If you want to know what a society values and what price and

value they place upon a transgression against what they value, you

have to look at their criminal code. Some societies do not, for example, have penalties that are particularly strong for crimes against

females. Some do. Some do not hold crimes against property much

higher than crimes against persons.

In our society, we have made some very basic judgments based

on our English jurisprudential systems that have been relatively

consistent. Having been the guy who has been the author—and it

is not hyperbole; I mean it literally—of every major piece of crime

legislation that has come out of this Congress since 1982, I believe

that we have operated in part up to now on the premise that the

threat of embarrassment and the threat of exposure in and of itself

was such a deterrent to most business men and women because of

the economic and social strata from which they come that it acted

as a greater deterrent than it might in other sectors of society. So

there was less need to have penalties that resulted in criminal time

being done in a Federal or a State prison.

The second thing that operates—and I know you all know this—

is it is much harder to make a complex white collar crime case as

a prosecutor than it is to make a criminal case, even if the criminal

case is murder or something of consequence, not some petty-ante

crime. For the reasons that Secretary Miller talked about, it is just

harder to do. It is easier to hide, and so on.

So there has been, I would say to Mr. Hills, in the testimony we

had in our first two hearings evidence that there are many fewer

referrals from the SEC to the Justice Department over the last decade or more. And this is not a Democrat/Republic thing; I am not

getting into any of that.

In speaking to members of the Criminal Division of the Justice

Department and U.S. Attorneys, there is not a reluctance to take

the case that is clear, but you would much rather take cases that

are more celebrated and less tortuous to make. It is human nature,

I think.

So for all those reasons, all I am attempting to do is try to bring

our criminal justice system and the penalties related to white collar

crime in line with a slightly different measure, and the measure is

what we do in other crimes: what is the degree of damage which

they do to society and to individuals?
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If a corporate executive knowingly and criminally violates the

laws that protect Americans’ pensions, ERISA, under the law it is

only a misdemeanor. You could cause someone to lose their pension

that was $1, $2, $3 million, or 50 people where the pensions added

up to $500 million, or 1,000 people, and you could only go to jail

for up to one year.

If you steal my car in my driveway in Delaware, which is only

a couple miles from the Pennsylvania border, and drive it across

the Pennsylvania line, 10 years from the Sentencing Commission

guidelines. So there is a real disparity here in terms of the value

of the thing taken and the punishment that results.

Also—and I will end my little exposition here and the rationale

behind our criminal law—it undercuts respect for the law when average Americans see and know the penalties people pay for crimes

that have much less consequence in their neighborhood, their society, the well-being of their friends and neighbors.

As you pointed out, Mr. Secretary, assuming that even a significant portion of it was a consequence of criminal fraud, you are talking about the loss of value, as you point out, if you add it all up,

exceeds the GDP of any other country. It is kind of hard for any

criminal, including going into Fort Knox, to have that kind of impact.

So I want to make it clear that I am not on a populist crusade

here. I might say that I think the Congress has acted pretty responsibly so far, in light of, by the way, what our constituents want

us to do. Our constituents want a dead dog delivered to somebody’s

doorstep. I am serious.

I guess you do have an idea. Our constituents out there—and it

doesn’t matter whether they are upper- or lower-income, middle-income; they want somebody to pay because they are angry. In some

cases, many of my constituents, from their perspective, and they

may be literally correct, have had their lives stolen from them in

the sense that if you are 56 years old and your 401(k) loses 70 percent of its value or is wiped out, you don’t have a whole lot of time

to make that up.

So, anyway, that is the context in which I am going to ask you

some of these questions. So I really am not looking for draconian

measures and I understand the limitations. Chairman Greenspan

was pretty straightforward about the notion that personal accountability focuses attention. Now, as the old joke goes, you have handled things way above my pay grade. You have been significant

businessmen and CEOs. You have had significant positions in the

Government.

Is there a correlation, in your view, between the amount of responsibility and accountability to which a corporate official and/or

board member is held and the due diligence that they are likely to

exercise in the performance of their duties?

I am not saying that I believe business men and women per se

are bad guys. I am not saying that at all, but is there a correlation,

and at what point do we impose a potential sanction where it begins to dissuade people from either being innovative or dissuades

them from participation on a board?

Let me conclude my little thing by saying this. When you go to

school and you are not a business major and you are a lawyer who
288

is not focusing on corporate questions, or you are an undergraduate

who is not a business major, you learn the basic sort of block structure of corporate America, corporations, and the notion of fiduciary

responsibility, who reports to whom, who has what responsibility,

where the stockholders stand, where the hired hands, including the

CEO, are, what the relationship of the board is to the operating officers. Technically, the board hires and fires those folks.

So in the context of responsibility, can you talk to me a little bit

about how, as you were saying, Mr. Hills, things have sort of

changed in the last 10, 15 years? I mean, I think most Americans

thought that if you had an audit committee on the board, they did

something other than, when the audit was presented by whomever,

just stamp it, that they were supposed to have some function other

than merely saying this is okay It is has been submitted a good auditing outfit, a good accounting firm, and it is all right.

What is the function of an audit committee? What was it envisioned to be? What has it become? What should it be?

Mr. HILLS. If I may, having been present at the creation, the notion was that the failure to have an independent audit committee

was a material weakness in the controls of the company.

Chairman BIDEN. I know what you mean, but for the record define what you mean by independent audit committee.

Mr. HILLS. Traditionally, I must say we have gotten into the

habit of using only one standard, objective independence. To be a

little colloquial about it, it means how many times did you play golf

with the chief executive officer. You know, are you a cousin, do you

get paid, do you have consulting fees?

Objective independence is very easy to find, although many

boards haven’t done it. But objective independence simply means

you have no other business relationships or social relationships

that would interfere with independent judgment.

It is way not near enough to have objective independence. I

would say it is a three-dimensional form. The second dimension is

you have to independently decide what you need to know. You can’t

just sit there and take what is handed to you. You need to know,

for example, that you need a management letter every year, the

management letter, not one that is concocted for the audit committee.

It is now public that in Waste Management for five years the

audit committee did not get a management letter and didn’t ask for

it. Yet, the management letter that went to the company had 12

items that the company absolutely had to change to have good accounts and they didn’t change it for five years. Nobody asked for

that because they did not objectively decide what they should see.

The third dimension of independence which is, in my judgment,

as important as the other two, maybe more so, is you will not have

an independent auditor unless you confer independence on them.

You have got to grab them by the neck and say you work for us,

you don’t work for the company, you are going to get fired the first

time we hear that you have given something to the company that

you haven’t told us about; we want the letters you have sent management, not the ones you frame for us. So independence has those

three dimensions. If you get those three dimensions, you have a

good audit committee.
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Chairman BIDEN. Now, gentlemen, what is the responsibility of

the board in this regard? In other words, is the board’s responsibility to insist that it be independent?

One of the arguments being debated right now in the conference—and you raised it, Secretary Miller, and I understand the

argument and I disagree with it. One of the differences, as Mr.

Doty knows, being the lawyer who advises clients on these issues,

is if the law changes as Hatch and I wrote it, it is going to require

not just a signature, but a certification to the SEC once every quarter that what we are submitting to you is accurate. If you knowingly or willfully violate that and say you knowingly supply false

information or you are involved in concocting that false information, then you are criminally liable.

Now, no one seems to argue with me that a CEO and a CFO

should be held accountable because they do the day-to-day management. But people have made the argument to me that about 10 or

20 percent of the chairmen of the board are neither CEO or CFO

or hold any other operating position within the corporation. They

are doing it part-time, not full-time, and therefore they shouldn’t

be held accountable to the same standard, even though it is ‘‘knowing,’’ which I find interesting, even though it is a criminal standard.

If we don’t hold the boards responsible for what on paper you

learn in Business 101 is their function, which is to oversee the

management of the company, then what are we doing here?

And I don’t think this is so black and white. I am prepared to

be shown that I am wrong on this, but I don’t know what you teach

them in Business 101. If, in fact, you say this board here has this

responsibility, but if everybody knows they don’t take it seriously

and it is not a full-time job and you can’t expect them to really do

the job, then why the hell do we have a board, or why don’t we say

really what it is?

Yet, we go around and we talk about the board like it has this

function that many of the Fortune 20, 25 CEOs whom I know and

have spoken to—not every one of them by any stretch of the imagination, but they all basically say to me, well, Joe, you can’t expect

these guys to be responsible. That is not their phrase. They can’t

be held to the same accountability as we can.

So how can you have an outfit that oversees and hold it to a lesser standard than the outfit that operates, when one of the reasons

you have the outfit that oversees is allegedly to protect the stockholders and the public from malfeasance or maintain good business

practices on the part of the operating officers?

Talk with me about that a minute.

Mr. MILLER. Well, Mr. Chairman, I would like to clarify a little

bit. I don’t believe there should be a lesser standard. Under corporate law, as I understand it, the board of directors is responsible

for the management and affairs of the corporation, period. The officers get their authority by delegation from the board; so it is the

board that is responsible. I don’t disagree.

My point about a chairman who is part-time was not that there

should have a lower standard of accountability fo him. In fact, if

such a chairman falsely signs a statement, he should go to jail. The

question is: does he know enough to sign that statement, as distin-
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guished from what else he knows? It was not a question of his

being allowed to sign something false. That would be unacceptable.

I want to go back to your point—and perhaps we can elucidate

on that. I don’t know that it would be popular, but it might be

more logical for the chairman of the audit committee to be signing,

who should have spent a lot more time on reviewing the financial

statements than a part-time chairman. Not every member of the

board can be on the audit committee, and it certainly is true some

directors will be disqualified if only independent directors can be

on the audit committee. So members of the audit committee will

have a degree of knowledge about the financial statements that

some other director won’t have.

I think your comments about the purpose of your legislation and

your approach are valuable comments and I just don’t want to pass

up an opportunity to say that if we had an ideal world, the only

criminal law we would need is the Golden Rule.

Chairman BIDEN. Yes, that is true.

Mr. MILLER. That is all we need. We know if we are acting

inproperly. We know when we are wrong. We know right and

wrong, but unfortunately we have found that not everyone wants

to adhere to what is right. So the problem in corporate management has come in waves over the centuries.

Don’t forget there was the era of the robber barons, and don’t forget there had to be huge reforms in securities law which now are

basically founded on disclosure, on the theory that if everybody has

the some information, they can act rational and there will be an

efficient market.

There was the time when monopolies arose and damaged the

economy. The response was to enact various antitrust, laws, including not only anti-monopoly laws, but also anti-price-fixing laws,

and so forth.

In the case that we are talking about now, if, in fact, all corporate managers treasured their reputation and their social standing, you wouldn’t need these sanctions. Unfortunately, not all those

in corporate managment or in business treasure their reputations.

Criminal syndicates do gain influence over various activities.

Criminal syndicates or equivalents may find their way into the executive suite.

So you need sanctions not because most corporate manager don’t

so care about their families, their reputations, their standing in the

community that they would never will falsify or misrepresent.

Sanctions are needed for the others, the minority, who will falsify

and misrepresent. I am appalled at the list of those who fall in the

latter category.

Chairman BIDEN. Mr. Doty, you advise a lot of serious people

and one of the things that seems to have—and, again, I have no

pride of authorship in this amendment. If it doesn’t make sense, I

am not trying to make the case for the amendment, really and

truly.

I am trying to figure out what the devil happened. There seems

to have been—‘‘meltdown’’ may be too pejorative a word, but there

seems to have been a diminution of the sense of responsibility that

board members had over the last decade or more, not because they

are bad. Maybe it is because they thought everything is so com-
291

plicated and things run so well and things are going so fine, all I

have to do is show up and get paid my $50 for the meeting, or my

$500,000. It is not because they were engaging in anything that

was wrong.

Mr. DOTY. Not bad people. They didn’t want bad things to happen.

Chairman BIDEN. Yes, but there seems to have been sort of a

morphing of the way in which the board related to management.

Now, I understand it is very popular now, this phrase about the

imperial CEO/chairman of the board doing both, one person controlling everything, et cetera.

Am I wrong, or has there been a diminution of the sense of responsibility when someone is asked to be on a board? When you

guys were asked to serve on boards as prominent businessmen 35

years ago, did you have a different sense of responsibility than if

you were asked at the same age, but you were the same age in

1995 being asked for the first time to serve on a board?

Mr. MILLER. I certainly have no different sense today than I had

40 years ago.

Chairman BIDEN. I don’t mean you personally. Do you understand what I am trying to get at it? What happened?

Mr. HILLS. There is a big difference. Thirty-five years ago—I

want on my first board 34 years ago. You were asked to go on the

board for your resume, not your advice. You got four crisp $100

bills under your luncheon plate that you didn’t have to show your

wife and you went home after a good lunch and you played golf

with the CEO on weekends and retreats. Yes, you were honest and

able, but there was not much expected. The responsibility has

evolved over these years.

I come to the same conclusion as to where we are today, Mr.

Chairman, but I don’t think there has been a diminution.

Chairman BIDEN. I see.

Mr. HILLS. I think the fundamental weaknesses have been there

and they show up when you have this burst of a bull market.

Chairman BIDEN. I see. That makes sense to me.

Mr. HILLS. I think that the responsibility of boards, to which

they can be held accountable more and more every year, is evolving.

Mr. MILLER. My experience is slightly different. Thirty years ago,

I did not serve on a board because of my resume. The directors I

served with took their responsibilities very seriously. I remember

a board I served on where an environmental issue came up before

environmental issues were as important as now, and the board

stepped in with great vigor to make sure the the company got

ahead of the curve and that its facilities met environmental standards higher than were then required.

The board of that company initiated the first environmental

audit. Now, this was 35 years ago. The directors were not just sitting there waiting for their checks and their lunch.

Mr. HILLS. I think you are right, but Peter Drucker wrote a book

about General Motors back in the 1930s. General Motors had the

perfect board in the 1930s. It had an independent audit committee,

but, boy, was that the exception.
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Mr. DOTY. Mr. Chairman, I have got to say the two men on my

right have done a great deal to cast the improvements that we

have seen in board governance over 30 years. I can’t speak for 30

years. I can speak for 25 or 20 or so, and I would say I think it

has gotten better.

I see directors who are hard-working people. I see directors who

have a heightened sense of what they have to do. I see directors

who are concerned and embarrassed by what they see going in on

some of these front-page stories. I see directors resigning from

boards because they think they belong to too many boards.

This is one of the things that happened. People began to collect

boards, and the man on my right has never made that mistake. He

has moved in and made a real contribution to the boards he has

sat on and seen it as his duty to change something for the better.

That is an attitude which I think is becoming more common among

directors.

One other point I would make is it has become more complicated.

The financial instruments have become more complicated. The accounting became more complicated. The SEC’s chief accountant,

with great freshness of candor, says, look, the rules are too complicated and at times they tempt auditors into creating complex tax

schemes.

So I think there is a combination of factors, plus the fact that

I do think when times are good, people tend to get a little lax, and

that is what Mr. Hills, I think, is referring to.

Chairman BIDEN. Let me ask you one other question. The strongest argument for any heightened accountability for a board member, let alone the chairman, is the world is a lot more complicated,

number one, and I don’t disagree with that.

Mr. DOTY. And you have seen specialization, Mr. Chairman; as

a result of that, specialization within the board.

Chairman BIDEN. The second reason offered is if there is a potential criminal sanction, because things have become so complicated

it will have such a chilling effect on good women and good men

being willing to serve on boards that what we will do is we will

have the reverse impact we are seeking.

We are going to get people who, for either the prestige or the $100 bill under the plate, figuratively speaking, will take the job.

You are not going to get serious people who have other enterprises

that they have to deal with and take care of participating.

Now, I have great respect for all three of you. What do you think,

both from your professional and your personal observation, would

be the chilling effect of a criminal standard? Is that enough to keep

an otherwise competent person from being willing to become a

chairman of a board? That is my question.

Mr. DOTY. Well, the SEC has long recognized that the way in

which you evaluate management directors’ conduct and the way in

which you evaluate independent directors’ conduct, outside directors, is quite different. The standard on the securities laws is the

same. Scienter, recklessness—all of those standards apply to you,

whether you are an independent director, a lawyer, an accountant,

or a management member.

But the test is in whether Congress makes it clear in adopting

this legislation that it intends not to have a chilling effect, that it
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seeks to have the best people join boards, and that it really is not

looking for targets in the board room, but instead it wants to ensure that directors do what Justice Douglas said they should do,

that they direct, that they work hard, that they not have too many

boards, that they take their duties seriously, and that they not be

willing to simply rely without good reasons for reliance.

Chairman BIDEN. My problem here is I don’t know how, in a

principled sense, I introduce legislation, which I did, requiring certification from a CEO and certification from a chief financial officer

and the liability incurred as a consequence of that legislation only

if there is a knowing or willful conduct to lie, to misstate—how you

do that and then not hold the chairman of the board responsible

to the same standard which requires a high burden of proof beyond

a reasonable doubt that you actually knowingly signed something

you knew to be false, not that you should have known.

Mr. DOTY. Well, I think anyone who knowingly signs something

they know to be false risks criminal prosecution now. But you do

have to recognize, I think, the difference between management

which controls the process whereby they can determine the accuracy of the financial information and the board of directors which

traditionally has not. They don’t have the human resources at their

beck and call that management has. That has been a fairly bright

line.

If, as the panel is saying, audit committees are more active in

hiring and firing the auditors and they are more involved in the

actual preparation of the financial statements, you will see heightened responsibility and accountability among audit committee

members and it will be a difficult question as to whether one

serves on an audit committee. But responsibility and accountability

and sanctions should follow actual capacity, ability, to affect the results and control of the resources. It shouldn’t just go with status.

Mr. MILLER. Mr. Chairman, put yourself in the position of being

a non-executive chairman of a company for a moment and realize

what Jim has just said about not controlling the process, not controlling the people. You are asked to sign a statement which reads

like an opinion of an auditing firm, reads that the statement fairly

presents the financial condition.

I think if you were required to do sign, and you did, and you

knew of nothing wrong, that would be fine. Your hesitancy might

be, ‘‘I don’t like to sign something when I have not been able to go

through a due diligence process on my own to ascertain that seven

layers down they aren’t doing something I don’t know about because I can’t see that at the level of supervision of the board’’. If

any officer signs falsely, he should be accountable. Is it fair to ask

non-employee to sign? If it is perceived to be unfair, the office of

non-executive chairman will disappear.

Chairman BIDEN. As Tip O’Neill said, all politics is local. All of

this gets personal in terms of how we view ourselves in that situation. I am a United States Senator. I am required every year to

sign off on rules that I vote for that hold me criminally liable if I

make a mistake.

I am required to sign off on documentation of how much money

this committee spends. I don’t have any idea. I don’t follow it. And

the budgets aren’t like the budgets of a corporation, but they are
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several million dollars. I am required to sign off on every expense.

If I, as chairman of the Foreign Relations Committee, send someone to Afghanistan, I am required to sign off on that.

It is a higher standard than criminal, than ‘‘knowing,’’ and I find

myself not easy sometimes about signing those things because I

wonder if I don’t have the right guy doing this, I haven’t spent the

40, 50, 60, 70 hours compiling this for the year. The public expects

me to be held responsible as a Senator who is one of 535 people

who can affect their lives, and if I screw up on that it may cost the

taxpayers a little bit of money—in terms of a $2 trillion budget, a

minuscule amount of money.

Yet, if a chairman of a board or a CEO of a major corporation,

where when they screw it up it may cause people tens of billions

of dollars—I don’t know. I guess part of what is at stake—and I

will end with this—part of what is at stake is the first guys that

want to hold everybody responsible are the business community.

They want to hold every car thief responsible and hang them by

their heels. They want to make sure that every welfare mother

cheat gets nailed. They want to make sure that every politician

who does anything wrong—and I agree with them—should be held

accountable.

And all of a sudden it comes to a place that affects the well-being

and security of may children and my family as much as anything

that anybody does, other than the President of the United States,

and people are saying, wait a minute, you have got to understand

this is a complicated job.

You are not saying that, I know, but I am saying that is the dilemma I am grappling with, without trying to turn this into, as I

said, any sort of a semi-populist initiative to go out and hold people

accountable when they shouldn’t be.

Mr. HILLS. What you can do and what the SEC can do is define

more sharply the responsibilities of these people who should be

held responsible. After 26 years, the duties of the audit committee

are just beginning to evolve.

Chairman BIDEN. I see.

Mr. HILLS. The Enron case won’t happen again. The Waste Management case won’t happen again. The audit committees won’t let

that happen. The compensation committee chairman will sooner or

later understand that if he doesn’t get independent advice on compensation, he is going to be responsible. If he takes advice only

from the consultant hired by the management, he is going to be responsible.

If the company continues to hire the auditors and if the auditors

continue to work for the company, the board will never be well-informed. If the audit committee asserts its responsibility—it is not

easy; you have got to sort of take them by the neck and shake them

a little bit—then you have all the eyes and ears you need to be responsible for the company.

If you have got 2 or 300 auditors looking at the operations and

they come to you and say, wow, you know, that depreciation schedule they have on that garbage collection down in Florida, it doesn’t

look to me like those trucks last that long, and you ignore that—

if you get a letter from a whistleblower and you pass it back to
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management and aren’t interested in the result, responsibility is

evolving. It is there, it will come.

Chairman BIDEN. With your permission—and I have trespassed

on your time a lot already—I have about four or five questions I

would like to submit to each of you rather than keep you here for

another hour-and-a-half. Maybe you would be willing to, in due

course, respond for the record. I will not overburden you, I promise

you. It is not a tome, it is not a deposition. It is relatively small.

I would also ask unanimous consent that the statement of Senator Hatch be submitted for the record, and Senator Grassley, at

the beginning of the hearing after my opening statement.

As I said, with your permission, I would like to be able to submit

to you some questions in writing, mainly to save you the time, but

let me conclude with one generic question.

You know that old expression, the wish is the father of the

thought, or whatever it is. I am mildly optimistic, and I don’t quite

know why, that this—maybe I do know why, because I have

watched my friends in the business community and how outraged

they are about what is happening, how many driveby shootings

there are. They are getting clipped and killed for having done nothing wrong, but just being part of a corporate establishment where

some bad actors have been engaged in serious, serious malfeasance.

What do you think is going to happen on August 15? Do you

think we are going to find, of the 17,000, I guess it is, American

corporations that you are going to have 15,000 of them coming forward fly-specking their statements and all of a sudden we are

going to find we are further in the hole than we were relative to

values? Do you think these scandals are going to be enough to have

self-effectuating house-cleaning? What do you think is going to happen, guys?

Mr. MILLER. I think you have good reason to be optimistic because while the impact has been great, the number of companies

that are responsible and want to be responsible is overwhelming.

You can rest assured that in executive suites today, regardless of

what legislation comes out, they are already hard at work figuring

out how to protect their company from any kinds of shortcomings

that have shown up in these other cases. So there is already a prophylactic effect taking place that will be pervasive.

Also, you have seen a change in attitude about some things that

were sacred cows. I think Warren Buffet is being very effective in

convincing a number of major companies to begin to account for

stock options in a different way. These are reforms that are now

being voluntarily moved along, I think, in reaction to this in the

sense that we have got to get ourselves in a position where we have

the trust and confidence of the American people. It is in our selfinterest.

After all, that Adam Smith viewpoint that the self-interest will

drive is a very, very powerful force in society. I think the self-interest will drive businessmen to make internal reforms, with or without legislation, that will improve the system. I think you have a

good reason to be optimistic. You shouldn’t stop the legislation because that reinforces against those who don’t want to play by the

rules. We do have the invasion of toxic interests into even a perfect

enterprise system. But the enterprise system is resilient, it is flexi-
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ble, it is self-healing, and it does not like this and it will change

it.

Chairman BIDEN. Mr. Hills?

Mr. HILLS. I think I have seen over the years an evolving responsibility on boards. I think I am optimistic, but on August 14 or 15,

you are going to have some house-cleaning. It is natural. Every

time you send an audit team out to see a facility that they haven’t

seen for six or seven years, they find stuff, and so it is not an unusual thing. By emphasizing the need for the certification, they are

cleaning the attics all this year instead of every two or three years.

So you will get some. If the media handles it right, I think that

will not be a serious problem.

Mr. DOTY. It will be interesting and the 10(q) will be worth reading.

Chairman BIDEN. Well stated. As chairman of the Foreign Relations Committee, it is amazing how many foreign leaders, heads of

state—well, that is an exaggeration. I have not seen that many

heads of state in the last month, but several heads of state, foreign

ministers, defense ministers, and counterpart parliamentarians are

absolutely perplexed, some of them with a little bit of glee, a little

bit of ‘‘I am glad to see your problems,’’ but them immediately realizing it is their problem if it is our problem.

You made the analogy to 9/11, Mr. Secretary. They are making

a similar analogy that this is of incredible consequence. In the

globalization of the economy, this has ripple effects that 35 years

ago would not have had nearly the effects it has—the dollar relative to the euro, the dollar relative to the yen, the dollar and its

strength and the failure to invest in the United States temporarily.

I mean, this is serious stuff.

Mr. HILLS. The chairman may remember Ambassador Tommy

Koh, from Singapore.

Chairman BIDEN. Yes.

Mr. HILLS. A week ago, we were in Singapore convening a session on corporate governance and significant people from eight

countries came and spent three days in intense discussions not unlike the one we are having here.

Chairman BIDEN. Did you discern the same thing that this concern is deep? I mean, it is not a concern that is confined to the

shores of the United States of America by any stretch of the imagination.

Mr. HILLS. They understand they have a much deeper problem.

Chairman BIDEN. Well, gentlemen, I can’t tell you how much I

appreciate you having given me this much time. As I said, I promise I will not submit more than four questions to each one of you.

And there is not an urgency in a matter of days, but as expeditiously as you could respond, I would appreciate it.

It sounds trite, but thank you for your service. You have rendered great service to this country in the past, and the fact that

you are willing to be here at this subcommittee is further evidence

that you are still in the game and we appreciate it a bunch. Thank

you very much.

We are adjourned.

[Whereupon, at 4:10 p.m., the subcommittee was adjourned.]

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