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 White Collar Crime

November 1, 2009
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Speakers
        Henry Pontell, Professor, University of California, Irvine;               Sally Simpson, Associate Professor, University of Maryland, College Park
The subprime mortgage industry collapse has led to a record number of foreclosures. In this environment, the interest mortgage fraud has risen, along with questions of how fraud contributed to the crisis. Henry Pontell and Sally Simpson discuss what they have learned about investigating and prosecuting white-collar criminals, the role of corporate ethics in America, and what policymakers and lawyers can learn from evidence of fraud.
  
  
          Transcript
**Kristina Rose:** Good afternoon. It is my pleasure to introduce Dr. Henry Pontell and Dr. Sally Simpson as part of the National Institute of Justice's “Research for the Real World” series. The subprime mortgage industry collapse has led to a record number of foreclosures, and many cities expect housing prices to continue to decline. In this environment, the interest mortgage fraud has risen, along with questions of how fraud contributed to the crisis.

We are so very lucky to have with us, here, two experts on white collar crime. They will discuss what they've learned about investigating and prosecuting white collar criminals, the role of corporate ethics in America, and what policymakers and lawyers can learn from evidence of fraud. They will also tell us about how they get access to white collar crime data and the similarities and the differences that they see between mortgage fraud, health care fraud, and the savings and loan crisis of the 1990s.

Dr. Pontell is a professor of criminology, law and society in the School of Social Ecology and of sociology in the School of Social Sciences at the University of California at Irvine. In 2001 he received the Association of Certified Fraud Examiners' Cressey Award for major lifetime contributions to the study, to the detection and the deterrence of fraud. He has written widely on the subjects of deviance and of white collar crime.

Dr. Simpson is the chair of criminology and criminal justice at the University of Maryland. In 2008 she received the Distinguished Scholar award from the American Society of Criminology's Division of Women on Crime. Like Dr. Pontell, Dr. Simpson has written extensively on the subject of white collar crime.

Please join me in welcoming Dr. Sally Simpson and Dr. Henry Pontell.

(Applause.)

**Henry Pontell:** Thank you very much for that nice introduction, and it's a pleasure being here today, to be able to talk to you about issues in white collar crime. So without any further ado, let's get started.

The title of my presentation today is “The Role of Fraud in Major Financial Debacles, Research and Policy Issues.” As some of you may know, I've done work in this area, now, for a number of years, starting with an NIJ grant in the early 1990s on the savings and loan debacle that I conducted with professors Kitty Calavita and Bob Tillman. So today, what I'd like to do is talk about issues that relate to the present, especially with what's going on now. The effects of fraud, I will argue in this presentation, have increasingly become a major problem. And major financial debacles, now that we live in a globalized economy, have far-reaching and massive effects.

There's questions here that I think are worth asking, and I'll cover these very briefly because of time limitations. One of the concerns is that of the field of economics versus criminology. In economics the problems and major debacles are generally seen as being due to “risky business,” whereas in criminology, a few of us at least, are arguing that most of this is due to fraud. And I'll talk about three historic financial meltdowns in this presentation; we'll get to those in a second. I'll talk about understanding the role of fraud and the implications for policy and research.

There is considerable disagreement and controversy, which still exists, regarding both the role and significance of fraud and white collar crime in major financial debacles that have occurred over the past quarter century in the United States. And I'll talk today briefly, about the savings and loan debacle of the 1980s, which was cleaned up in the 1990s and paid off in the turn of the century; the corporate and accounting scandals, which occurred in 2002 with the blow-up of Enron and Arthur Andersen and related companies; and finally I'll get to the subprime mortgage industry meltdown and the current global economic crisis.

The controversy about fraud entails not only criminological and law enforcement concerns, but fundamental questions of finance, economics, politics, lawmaking and related areas such as regulation. So, the, the bottom line here is, essentially, that a comprehensive scientific understanding of white collar crime really requires a multidisciplinary perspective. Looking at this strictly in disciplinary terms gives you a very myopic view.

What I call the fraud minimalist position represents one side of the question of the role and significance of fraud. And the fraud minimalists are influenced by ideas from the law and economics literature on corporate governance theory. And, very quickly again, I'm not going to get into all the specifics — we can talk about it later — but the contemporary law and economics movement has been heavily influenced by the work of Frank Easterbrook and Daniel Fischel, who published a book called *The Economic Structure of Corporate Law*(Harvard University Press, 1991), considered by many to be the “bible” of the new economics of law movement. And if you take a look at this book, and I don't have time to give you all the quotes, but there are many parts of this book, which essentially trivialize the notion of fraud. And by that they say, and I say in return, and I say here is the claim that markets can readily identify and correct fraud, and therefore, it does not require any special attention or regulatory policymaking.

Fraud minimalist assertions have largely guided U.S. financial regulatory policies. They are also totally at odds with actual events that transpired in the savings and loan debacle of the 1980s, the corporate and accounting scandals of 2002, and the current banking crisis in the United States. Conventional law and economics theorizing regarding corporate governance not only denies that there is a significant degree of fraud in economic markets, but it counts the major financial scandals, when they do occur, in terms of larger structural disorders, mismanagement and incompetence, government and regulatory interference, overzealous enforcement efforts, and “risky business” that is a natural feature of free markets.

The perspective stands in direct opposition to the major tenets of almost all white collar and corporate crime theorizing and research conducted over the past 15 years. Such criminological research focuses largely on organizational structures that prevent or encourage fraud, motivational mechanisms, regulatory regimes, criminogenic industry environments, inadequate laws and limited enforcing capacity. And some of these issues, Professor Simpson will be talking about in a few moments.

Wheeler and Rothman's classic conceptualization of the organization as weapon is very important here for understanding the significance and role of fraud in major financial debacles. They claim that organizations can become vehicles for fraud — that is, organizations themselves are used as the weapon. Insiders in control may use companies as both a sword and a shield. In other words, those who run organizations can effectively neutralize both internal and external controls and thus optimize the firm for fraud — that is, create phony wealth through creative accounting and misstating assets, which we've seen happen in the savings and loan debacle, we've seen it happen in the corporate and accounting scandals, and we will undoubtedly see it in the current scandal.

These are known as control frauds. The term “control fraud,” by the way, comes from a student's dissertation, Bill Black, who maybe some of you have seen in the news; he now teaches law and economics at the University of Missouri. He came up with this term, which basically comes to mean that the fraud is perpetrated by controlling insiders of organizations. In organizations with large assets, the results of these frauds can be devastating.

Understanding the role of fraud in major financial debacles is essential for at least three reasons. The first: accurately relating history and economic realities without political or ideological blinders. Informing both social scientific theories and the law regarding corporate crime and corporate governance. And finally, for effective policymaking for the prevention of future abuses. So this is — it sounds like it's an esoteric exercise. It really isn't. It relates very closely to history, it relates very closely to social science, and of course, it relates very closely to policy.

The first debacle I'll go through, the U.S. savings and loan thrift crisis — and this is taking four books, 15 articles and summarizing it in a paragraph — essentially was created by a series of misdirected deregulatory moves by the Reagan administration in response to losses in the industry brought on by a long period of stagnant economic growth, coupled with high inflation in the U.S., which followed the Vietnam War. That's essentially where the crisis came from. At least that's the consensus is, that it came from. The S&L crisis eventually cost Americans about $130 billion — the estimates there are between $130 and $150 billion, depending on how you count it, which really doesn't sound like too much money these days, given that AIG has already taken in, I think, over $170 billion worth of bailout money — but that was the whole crisis.

And in that crisis, NIJ-funded research actually found numerous insider or control frauds, and these, typology here that we use to categorize these numerous types of frauds were unlawful risk taking, collective embezzlement and covering up. The fraud minimalist position, in contrast, on the S&L crisis, said that it was about moral hazard brought on by economic circumstances and government deposit insurance combined with ineffective regulation, which lead thrift owners to legally take risks and “gamble for resurrection” — that is, try to save their ailing institutions, and that's not necessarily fraud. Unfortunately the data don't bear that point out, but that is the argument.

Government reports estimated that fraud played a central role in 70 to 80 percent of all thrift failures. These were reports from, mostly, the GAO, which had done intensive studies at the time. Some regulators that we interviewed claimed that when the indirect and direct costs of S&L were considered, that they would literally add up to 100 percent of resolution cost. The idea being that if only 20 percent of the loans made in a financial institution were fraudulent, that 20 percent going bad could have lead to the entire insolvency of the institution, leading to 100 percent of the cost of resolution.

The U.S. corporate and accounting scandals: the second debacle. Here we have the companies all recognize that Enron, Adelphia, WorldCom, Arthur Andersen, Tyco, Global Crossing and the others — there was over $4 trillion in lost market value worldwide due to that particular crash. And, another thing we could say is that no lessons were learned from the savings and loan crisis regarding effective regulation, assets that have no clear values, accounting abuses or control frauds. If you look at what was going on in those companies, and what they were doing, they were essentially replicating what had happened in the S&L crisis, but just not in financial institutions and corporations. The corporate and accounting scandals also interestingly negate the basic tenet of corporate governance theory from the free market law and economics literature upon which many regulatory policies in modern capitalist countries are based. And that is that only honest companies could pass the inspection of experienced outside auditors because “the reputational cost of false certification to accounting firms is greater than any gains to be made.” So basically, a rational choice model there, which, in essence, turns out to be untrue. The empirical reality is that every fraudulent savings and loan received certification from a reputable accounting firm, and the same pattern is found in the corporate and accounting scandals.

Now, this brings us to the subprime mortgage meltdown. Again, here we see the devastating and most likely to be unprecedented effects of endemic fraud, this time in the home mortgage industry. The subprime mortgages, as they're called, are loans that were extended to borrowers with poor credit history, really lie at the bottom of much of this scandal; these were high-interest, high-risk loans. Now, traditional mortgage fraud involves three major types: fraud for profit, where you could have multiple loans and elaborate schemes perpetrated to gain illicit proceeds from property sales. You can also have gross misrepresentations concerning appraisals, and loan documents are common in fraud for profit schemes, and participants are frequently paid for their participation. You also have what's known as fraud for property, which can entail minor misrepresentations by the applicants, solely for the purpose of purchasing property. And finally, you can have predatory lending, which has also been uncovered in the current crisis, by loan originators engaging in practices such as failure to, to disclose fees and bait-and-switch loan offers.

All of these can be tied up in what you could call origination fraud. Origination fraud involves a direct, indirect or complicit intentional misrepresentation and involvement by anyone included in the loan origination process for the purpose of qualifying and obtaining a mortgage from a borrower who would otherwise not qualify. Origination fraud includes intentionally overlooking fraudulent documents, manipulating data and fabricating false documentation.

Now, relating this to the current global crisis ... You know I'm also doing work on what I'm calling trivializing white collar crime or trivializing the sense of theory, trivializing the sense of policymaking. And it seems that there's also the same pattern going on here, and I'll just give you a couple of examples. The track data, which is kept at the University of Syracuse, on federal prosecutions of white collar crime relates the degree of proactive white collar crime enforcement in the recent past, and that data show a 36 percent staff reduction since 2001 in FBI agents dealing with white collar crime. The number of criminal cases brought by the FBI has dropped by slightly more than one quarter during the same time period. And what's called the fall-off rate in white collar crime prosecutions has reached the 50 percent level. This is now happening before the current crisis.

Former U.S. Attorney General., former U.S. Attorney General Mukasey refused to create a national task force and likened the current mortgage-based financial crisis before it ballooned into what it is now as white collar street crime — that it was something to be left up to, to individual U.S. attorney offices to deal with, that there was no, no need for a national coordinated effort.

As early as 2004, the FBI had warned about the massive fraud that was likely to occur. And this was ignored by officials higher up, as resources continued to be devoted to terrorism. And in the words of the FBI, the current situation “had the potential to be an epidemic.”

Now under investigation, since that time: mortgage companies that made fraudulent loans, investment firms that sold billions in securities backed by shaky or fraudulent subprime mortgages, and credit rating agencies that gave high marks to worthless securities — the “toxic assets” that we always hear about and that failed to protect investors — just a massive failure at all levels. The conclusion here is that it's often very difficult to distinguish white collar crime and especially controlled frauds from ordinary business transactions. As British criminologist Michael Levi notes, “Since the aim of the more sophisticated fraudster is to manufacture the appearance of an ordinary business loss, or at worst of a ‘slippery slope,' rather than deliberate fraud, the actual allocation of any given business failure to any of these categories is highly problematic.”

It was the ability to grow rapidly using assets that had no clear market value and that could create phony income that was central in the S&L control frauds. Similarly, the corporate and accounting scandals and more recent subprime industry debacle reflect these similar patterns of financial loss and fraud. Any proposals for reform and prevention, whether directed at deposit insurance, financial and lending institutions, accounting, securities markets, or corporate governance, cannot assume away the problems of assets that have no clear values, accounting abuses or control frauds. In other words, if this doesn't become part of policy, then we will see the same debacles repeat over time. And, as we're finding out, they're going to repeat in much bigger ways. Policies that do not explicitly recognize the potential devastation of control frauds would not only be ineffective, but would serve as virtual blueprints for future, future financial disasters.

So, in terms of future research, the types of issues that I think would be fruitful would include looking at financial regulatory issues, lawmaking, criminogenic environments that are induced by such lawmaking or non-criminogenic environments, enforcement issues and obstacles, what obstacles and issues are there for enforcers, victimization issues — that is, who are the victims here, and what are the costs to them — and of course corporate governance and compliance issues. And so on that note, what I'd like to do is introduce Professor Sally Simpson who will talk about corporate crime deterrence issues.

**Sally Simpson:** Thank you, Professor Pontell. And I would like to thank all of you for coming and inviting me today to talk about something that is very near and dear to my heart. Like Dr. Pontell, I've done a lot of research in the area of, more specifically, corporate crime, and that's going to be the subject of what I am talking about today — and in particular, corporate crime deterrence, or more broadly, prevention and control of corporate crime. This is based in part, this presentation, on research that was funded by the National Institute of Justice. I received a grant to study corporate environmental crime, and I am presenting some of the results from that study.

So, what am I going to talk about today? How am I going to go about my discussion? First of all, I think that because Dr. Pontell focused more broadly on white collar crime, I'm going to talk a little bit more about corporate crime and provide you with the definition that I follow using corporate crime. I'm going to talk a little bit about the different strategies that there are for corporate crime control out there in the field and talk about empirical evidence regarding strategies from two studies that I have conducted.

The first study is a vignette study that was conducted in the mid 1990s, which uses hypothetical scenarios to find out about managerial decision making. And in deterrence terms, we're really talking about micro-level data focused around perceptual deterrence. The other study that I'm going to use comes from the environmental compliance study, and I'm going to be looking at corporations as actors, and I'm going to be looking at macro and objective deterrence in that case. And I'm going to use the evidence from these two studies to address the following questions: What does this evidence tell us about corporate crime deterrence?

So, what is corporate crime? I rely on *Braithwaite*'s definition of corporate crime, and I'll give you a quote here: “Corporate crime is the conduct of a corporation or of employees acting on behalf of the corporation, which is proscribed and punishable by law.” This includes acts by managers or the company itself. It excludes offenses against the company for the personal benefit of managers, such as embezzlement, and it does not distinguish the type of legal system through which sanctions are brought. So, we're talking about a regulatory legal system, a civil legal system, as well as a criminal justice system. I should note as well that the definition that *Braithwaite* and I incorporate does not rely on the corporation to be found guilty of an act in order to be defined as a corporate criminal.

I'm also going to talk about, drawing again from John *Braithwaite*, the notion of a pyramid of enforcement. *Braithwaite* has talked in great depth about the mix between punitive and more cooperative sanctions that may come from different bodies of justice, as well as building around the idea of an ethical base and other kinds of informal controls, which inhibit people from offending. And so I'm going to talk a little bit about the implications of my findings for a pyramid of enforcement, and then I am going to distinguish sanctions sources and targets because, as I'll discuss briefly in the next couple of slides, that we have individual actors, and we have corporate actors. And we have different sanction sources, so sanctions can come from regulatory justice, civil justice and criminal justice. All of those things are important, and all of them need to be taken into account when we talk about the control and prevention of corporate crime.

What are some issues that we don't understand very well in the literature? First, we do not understand why managers make the decisions that they do in a corporate conduct, in a corporate context. This is, in part, because there's just not that much data out there that allows us to investigate this question. A lot of it is speculative. A lot of it is based on case studies, which are excellent, but they can't be generalized beyond that specific case. And a lot of it is based in business ethics research, which is very helpful, but there's some controversy in the field as to whether unethical decisions are the same as illegal decisions.

Additionally, we don't understand whether firm characteristics affect who gets punished and how they're punished — this is to say, does the organizational characteristics, such as size, such as profitability, affect whether or not they're punished and what kind of sanctions they get? We also don't understand the relationship between what sanctions a company is actually delivered and company recidivism. And finally, we don't have a good understanding of how deterrence and compliance as strategies of prevention and control actually fit together.

So, this is a tale of two studies, and the first study I'm going to talk about is, is a vignette survey, a factorial survey that was conducted at a Fortune 500 company and also the same survey was administered to middle-level managers and MBA decision makers and students at several universities in the Washington, D.C., area. We had three different scenarios that people were going to be evaluating, and these are the three types of offenses that they were evaluating: price fixing, an Environmental Protection Agency violation and bribery — all three clearly criminal, civil or regulatory violations depending on how you look at it.

We ended up with 78 respondents, which isn't a very large end, but your vignette is your unit of analysis, so it's 78 times three; we ended up with 234 observations. This is a great study because you experimentally design your hypothetical scenarios based on what it is that we know in the literature that affects, or is likely to affect, someone's decision making. And then we have a number of questions that follow the hypothetical scenarios.

Now, how did we measure deterrence in this? Well, we asked these managers and students, “What is the chance that you or your company” — and they're two separate questions — “would be arrested, prosecuted, sued or investigated by a regulatory agency?” So, you can see these are all separate questions, but they're getting at all of the different kinds of law that are used in the control and prevention of corporate crime. “How much of a problem would that create for you if you were arrested, sued or investigated?” And these were measured on an 11-point scale, from “There's zero chance that I would be arrested or prosecuted, sued” or “100 percent chance.” In terms of seriousness: not a problem to a really big problem.

Now, I know that I shouldn't be presenting results like this, but this is a very simple table, and I think it's important for a number of reasons. What this tells you is, it breaks deterrence down into certainty and severity, and then it talks about the three different regulatory systems: criminal, civil and regulatory. And then it compares the targets: individual versus company. And as you can see, both certainty and severity differ significantly in terms of how likely they think they are to, to have those things happen to them if they were to behave badly and how consequential it would be. They believe that the company is more likely to be investigated or prosecuted, they're more likely to be sued, and they're more likely to have some regulatory intervention compared to the individual manager; and those are significant differences. However, conversely and not surprisingly, we see that they think the sanctions are going to be more personally consequential. So, the companies are fairly high, but they see that costs will be pretty high to them compared to the company.

Another thing though, that I think is very important from, from these results is that a lot of the arguments about why corporate crime happens is because people believe that managers don't think there's a very high likelihood that they're going to be discovered for doing the behaviors. But as you can see from these tables, actually the mean levels are not as low as one might expect if we were to believe that argument. Frankly, at the individual level it's about a 38 percent, or 35 percent to 46 percent, likelihood of discovery, which does vary between civil, criminal and regulatory. They think the regulatory agencies are more likely to catch them than are the civil or criminal kinds of cases. However, and nonetheless, I think it's important to recognize that they think their chances of discovery are fairly significant, and that the costs of discovery are very high, and I think that this is an important slide to show that.
 
Now this is a complicated figure because what we're trying to do is suggest to you that the relationship between formal sanctions and offending is not a simple one. We also, in our policy areas, like to believe that formal sanctions will deter corporate offending, and it should be a direct relationship, but research has suggested that it's more complicated than that, and that this model tries to take into account other factors that may affect corporate offending other than just formal sanctions. And it acknowledges that formal sanctions may actually operate through other things, such as our moral evaluations of how wrong the acts are, for instance. Or through “What do we think the consequences of behaving this way is likely to bring to us?”  So, “Is it going to be a good thing if I do this? Am I going to improve my employment position?” Or, “Am I going to bring disrespect to the company?” So the outcome expectancy is really based around what do they think is going to happen as a consequence of behaving illegally, assuming that they're not caught? OK? That's assuming that they're not caught.

And obedience to authority is a very important element in corporate crime, because almost all of the studies that look at the role of top management suggest that the tone and behavior and guidance provided by top management within corporations is a strong influence on the level of offending within companies. And so, obedience to authority is really tapping into whether or not someone was told to do it in the scenario. OK?

So what did we try to do? We wanted to know how likely a respondent would act like this manager in the hypothetical scenario, and in all the hypothetical scenarios the managers offend; so it's really a measurement of how likely are you to offend. What did we find? When we ran a LISREL model — we won't talk about that, but it was a good fit to the data — and we discovered that we had significant relationships for all of our predicted variables except for one. We found that when we control for moral evaluations and outcome expectancies, suddenly our formal sanction variable had a positive and significant effect on offending. Now, that says that when they think sanctions are likely, and they think they're consequential, they're more likely to offend. Bazaar.

Now, what we really found was that formal sanctions operated through other important variables, that their indirect effects were manifest through outcome expectancies and through moral evaluations, and that if you took the sum total of the effect of formal sanctions, through all of their effects, we found that they had the predicted relationships. So, formal sanctions did deter, but they did so through their relationship with other variables. So, what does this tell us? We believe it tells us that formal sanction threats have a deterrent value for the way managers think, but they have a value to the extent that they influence moral reasoning and interact with informal sanction threats. In other words, is the company going to take the behavior seriously? Are they going to fire someone? Will there be some compliance issues if you behave in that kind of way. Are you going to damage the reputation of the company?

Our results also challenge the idea, however, that ethics alone will make it all right. Our results suggest no, that you really need to have both. You need to have formal sanctions as well as well as a strong ethical base, and informal sanctions in order to have a deterrent effect. So this suggests that *Braithwaite*'s argument about an enforcement pyramid makes a lot of empirical sense, at least based on what we have found. The “benign big gun” is the term that Ayres and *Braithwaite* give to it. It's kind of like “walk softly and carry a big stick.” Have an intervention at lower levels, use a, a more cooperative strategy if you can, and then if you don't get the kind of compliance that you want, come in with the big stick of punitive sanctions.

The second study was a study of environmental compliance. Oops, I went through that a little bit too fast. And it looks at corporations, and it looks at corporate characteristics. And we, we took data from the Environmental Protection Agency and aggregated that data up from the amount of chemicals that go out in a pipe to a company from a facility. It was a three-year project that turned into a six-year project for some very difficult level-of-aggregation problems. But what was really good about it was that the EPA has self-report data. And Dr. Pontell had talked about the difficulty of some of the data earlier during our lunch conversation that it's all official data. Well, we had some self-report data that we wanted to investigate.

So we looked at self-reported data; we looked at company characteristics; we followed 64 companies from 1995 through 2000, which was reduced because, as we all know, companies consolidated and some went out of business and so on. But, that time-series data gave us, actually, 4,379 time points to analyze. We aggregated this to the quarter and a couple of interesting findings about these companies: Most of them were large-scale made — and we focused only on major polluters — and almost all of them were law-abiding most of the time. And this is not just based on the self-reports, this is also based on inspections, and it's also based on other kinds of data that the EPA keep. So it's interesting that the majority were law-abiding most of the time and the majority of them over-complied.

Now, what does over-compliance mean? That means that they actually went far beyond what they needed to be doing in order to meet their permitted levels. Over-compliance, by the way, is a subject that is not very well understood, and it's certainly something that the EPA and people are very interested in exploring. We looked at deterrence in the following way: We wanted to see whether or not sanctions in period one affected reoffending in period two. And we looked at EPA monitoring inspections; we looked at EPA sanctions. We divided it by formal; we divided it into informal. We looked at civil; we looked at criminal. We had all of them in our analysis. And what did we find? Neither a command in control — a punitive deterrent strategy — or a cooperative strategy lowered environmental offending by companies. There was no deterrent effect regardless of how we measured it, regardless of the kind of data that we used.

This is important because it suggests, although we may have a general idea of how deterrence processes may work at the individual level, we have very little understanding of how they work at the corporate level. What did we find in terms of the relationship between firm characteristics and sanctions? Well, we found firms with more violations are more likely to be inspected. Well, that's good because it suggests that there's some rational strategy going on here. However, there is a simultaneity problem here, in that it's hard to unravel which comes first. We found firms with more violations receive more serious sanctions. Again, that's good news because that's what we would expect. We find larger companies are more likely to be inspected, and firms with more facilities tend to receive more severe sanctions.

And this is consistent with what an EPA strategy might, might be regarding bringing some kind of, of sanction against a company, in that you're getting bigger bang for the buck. If you go after the big companies, if you go after the companies with multiple facilities, you can't get everyone, so go after the companies that you might get a bigger bang for the buck. We also found that firms with higher liquidity tend to receive more severe sanctions. This suggests that the firms may actually be in trouble, which is why they've got liquidity rather than assets, but it may also suggest that the firms can pay because they have some liquidity. We, we really don't know the answers.

So what do we conclude? Aggregate objective data don't support deterrence. Perceptual data suggest that sanctions deter, but not directly. So, amid the current calls to get tough on crime is an assumption, which is rarely tested, that ratcheting up punishment will deter corporate criminals. That is a strong assumption, but there's very little empirical evidence to support it. The research I presented here suggests that corporate deterrence is allusive and complex, and there're clearly factors other than the threat of formal sanctions that affect corporate offending and reoffending, yet until we can conduct more studies and have better data, identification of these factors will be compromised and prevention and control policies will lack an empirical foundation.**Kristina Rose:** We can now open up the floor for any questions for Dr. Pontell or Dr. Simpson. Jolene?

**Questioner:** If I was a U.S. attorney and my responsibility was corporate crime, are there some, three things you'd tell me to watch for? What, what advice would you give me if I was a U.S. attorney involved in prosecuting, gathering information and prosecuting white collar in my jurisdiction?

**Sally Simpson:** Well, one thing that I would suggest is that you really need to have a cooperative relationship with law enforcement and with your regulators who are responsible for a variety of different behaviors by that company. I don't know what the crime would be, but if it was an environmental crime, then close cooperation with the Environmental Protection Agency, and what, what the history of that company is, how many facilities they have there. I think there are some investigative strategies that, that would be useful. I would also — and I think it's difficult for attorneys to get good information from inside the company, because companies, as Dr. Pontell pointed out, tend to collapse into secrecy, so certainly using whatever powers you have to use your discovery powers to get information and documents and so on is really critical. You also utilize whistle-blowers. A lot of corporate crime comes to light because of whistle-blowers, so there may be sources within the company that don't feel very good about what's been going on.

**Rose:** Any suggestions?

**Henry Pontell:** I would agree with Sally, and also add that maybe white collar crime enforcement is proactive. And so if the prosecutor's office is not really concerned with it, it really doesn't exist as crime, per se. And so making, establishing these kinds of agency connections is very important, and also, I think, seeing what types of complaints and what kinds of issues are occurring in a particular jurisdiction would really guide where those efforts would have to be. So, for example, if there were a state of financial crimes going on, a good idea might be to establish the necessary connections with the financial regulatory agencies in the area et cetera., so that there's expertise available to prosecute those particular types of crimes. So, it really depends on the jurisdiction, and I think, as Sally said, you know, making those kinds of connections would be very important, especially given the proactive nature of these types of efforts.

**Questioner:** So, can I ask a follow-up question? Now, if I was a state legislator, and I wanted to pass some laws, do you have any advice for me there?

**Simpson:** Evaluate what works and what doesn't work before you start passing new laws. That would be my recommendation.

**Questioner:** And what do you know about what works? What do you all, what can you already tell me?

**Simpson:** Well, I can tell you from what I presented today, we do know that formal sanctions don't seem to have a tremendous impact on the behavior of corporations, so certainly, maybe focusing on individuals within the companies. And, and this has been a policy of the Department of Justice, I know, in a variety of different areas, like price fixing, for instance, that you go after the responsible individuals because the assumption is that, again, that will have more of a deterrent effect because, based on my data, people care more about their own consequences than they do about the company per se. But I think that one of the major problems with telling you what works and what doesn't is that the data are so bad. And there are so few systematic studies that are out there on corporate crime that can help us evaluate whether or not certain policies are good or not, or are successful of not. And as I've said in my other contexts that we know a lot about different kinds of street crime intervention strategies, drug courts and so on, because part of the study is get evaluation money. And there's very little evaluation of any kinds of corporate crime interventions and controls. There's no experimental studies. Does this kind of sanction work over that kind of sanction? If we think about all of the gun studies that have been done, and people say, “Oh, well you can't police departments to cooperate in some randomized experiment.” We know that isn't true. And yet the same arguments are made about “Well you can't randomly assign different kinds of outcomes at these regulatory agencies,” and my question is, “Why not?” If the police will do it, and the courts will do it, why won't regulatory agencies do it? Or why won't the Department of Justice do it in a study?

**Rose:** Henry?

**Pontell:** I would agree, again, with Sally. I would also stratify what we're talking about here in terms of whether we're talking about lower level white collar economic crimes or what a Fortune reporter once called “starched white collar crimes.” And what, what Sally is saying is true for the vast bulk of traditional types of white collar crimes. What we're seeing in these debacles of late, the last 20 years, is a nontraditional type of white collar crime: what I've called and others have called “control frauds.” So, until that is taken seriously, until financial regulation is taken seriously in legislation, having to do with white collar crime, we're going to see these things repeated over and over again. There is a huge legal and cultural lag in our understanding of these types of frauds, which is why we read today about “Well, no one could predict that this was going to happen.” And you know, and, and so no one's ready for it, and then when it happens we, we sit by, clean it up, deal with it, pay for it, et cetera. These debacles will get larger and larger, and it's a different type — really, we're talking about different types of frauds here. And in terms of legislation, until the types of issues I was talking about — assets that have no clear values and control frauds — are taken into account, any new policies or revised policies will essentially be blueprints for future disasters. That's what I believe after looking at the limited data that we have through case studies and through the histories of these past debacles and looking at regulatory data as well as criminal data.

**Questioner:** So, if you were in charge of the world, you would make this a higher priority, you would instate legislatures in the U.S. attorney's office, in places like that?

**Pontell:** Well, in terms of federal and state legislation, absolutely. This would be a much higher priority. Given the costs, it's a very rational road to take, to take it seriously.

**Rose:** We have another question here.

**Questioner:** Yes. Sally, how have our law enforcement agencies changed when it comes in terms to the differences and the type of crimes that different agencies or companies can commit. For instance, back in the 1980s there wasn't as much computer opportunity as there is today. So how, how have those opportunities increased, and how has the way we go after them — different companies.

**Simpson:** Well, it's an excellent question because, as we know, fraudsters become very sophisticated as more opportunities open up to them. And so the stimulus package in of itself is producing all these kinds of new opportunities for fraud. And, and the computer just enhances those and makes it even more difficult to track. I think that the new technologies suggest that we need to retool a lot of our police departments and offer a lot more training on fraud prevention and fraud investigation, computer forensics and those kinds of things. But I think it all goes back to the notion of resources — that we have an under-resourced police department relative to more traditional frauds. They're under-resourced in terms of more advanced and sophisticated frauds, and then if you start taking the corporate crime and regulatory agencies into effect and the under-resourcing at that level, it's, it's really a, a difficult problem to, to solve. And I think we have to take it piece by piece because we're not going to do it in one fell swoop.

**Questioner:** I'm a former fraud prosecutor for the U.S. Department of Justice, and actually, the, there has been some innovation to try and get more enforcement with the Qui Tam legislation, the voluntary disclosure reports, that all began — the whole fraud in, in corporations began, as many of us will remember, with the $100,000 toilet, or whatever it was, that the Defense Department was paying for, and, and I'm wondering if these kind — the Qui Tam legislation, the voluntary disclosure, where the company — well a Qui Tam is where you have an insider who's willing to come forward and tell on a company, and if the government recovers, whatever amount of money the government recovers from the corporation, this insider gets a big percent. A lot of those Qui Tam suits have happened, and a lot of people make a lot of money off of them; there's a lot of incentive to tell on the company. And then the voluntary disclosure reports allow the company to turn itself in and make a report to the government, and make restitution to the government. So has that changed? Are those kind — there may be many more, but has that changed what we're seeing in corporate fraud? Has that made any influence in returns?

**Simpson:** I haven't looked at the Qui Tam data lately, but my understanding was that there still wasn't a large number — you know, the numbers were still pretty small on that, and I think it goes back to the notion of loyalty to one's organization and corporation.

**Questioner:** Are you kidding? You've seen the kind of recovery amounts people ...

**Simpson:** I know, but if we think about it, if we put it in perspective of how much fraud there is, it's a relatively small drop in the bucket compared to how much could be coming out. And that's based on official data. We don't know how much fraud there is out there, right? So that's one issue that I would raise. I think it's not surprising, knowing what we know about corporate cultures, that you don't have more people coming forward. In terms of the voluntary reporting, I attended a conference that had a number of attorneys who worked for companies that raised this as not such a positive thing for the company. That it brought a number — there are a number of nonlegal consequences for coming forward and admitting that there are problems, so there's a suppression, I think, of wanting to come forward and admit wrongdoing because you get publicity. And negative publicity means that perhaps your company is not being managed properly and so on. So there're again, internal pressures not to take advantage of some of, some of those opportunities.

**Rose:** Henry?

**Pontell:** I would basically agree, especially with the last point.

**Questioner:** Dr. Pontell, you mentioned that the prevailing law and economics paradigm pays very little attention to the role of fraud, and I was wondering if you thought there was anything that might change, that might cause a shift in the focus, if the current crisis might be enough to move economics into an area that explores that more, or the law and psychology, or law and economics and psychology, if it might push anything or is it more the role of fraud and all that?

**Pontell:** That's a very interesting question. I think, I think it goes beyond, even beyond that in terms of — essentially law and economics literature negates the role of fraud. Anything NIJ, criminologists or anyone else would have to say in this policy debate would just be nonsense. And so I think the way to change that attitude, besides what's going on now, there isn't too much noise that you hear from the other side right now, for good reason, I feel.

**Questioner:** Who is the other side?

**Pontell:** The other side being law and economics free market advocates. They seem to have had their way, pretty much, in the current situation — although there's some debate about that, to be fair. I think the way to do it is to provide the kinds of empirical studies and to do the kind of research that will challenge those particular theories. And the interesting thing — and I sat on panels with Milton Friedman's son, who takes a very different viewpoint from mine, and I've sat on panels with James Barth, another economist — and I'm not an economist but I'm learning as much as I can — and what's interesting to me is that when they put forth these particular, what I would call ideological positions; they provide no data about crime or fraud. It's about bankruptcy, it's about bad assets, it's about economic data, with nothing specific about fraud. And so, you can challenge those theories pretty easily when you have reasonable data. It doesn't even have to be perfect. With all the problems that Sally's brought up, it doesn't have to be perfect. If you have reasonable data, then you can challenge those positions quite readily from a social science perspective. And that's what needs to be done.

**Rose:** We may have time for one more question. Did I see another hand raised here? Angela?

**Questioner:** Well, I guess this kind of brings us back somewhat to Jolene's questions, so given where we currently are and just the impact that we've been able to have on street crimes, if you will, how do we make an impact in this area. What, I mean, what tangible steps, so to speak, what can we do at this point? You know, everybody's asking the question “How do we avoid this?” We've got many examples of it; what do we do now?

**Pontell:** Why don't you give us a tough question?

**Simpson:** We're 30 years behind where we were, in terms of street crime and understanding the evidence-based research that is, has been dominating our paradigm for probably 10 years as criminologists. We're so far behind that in the area of white collar and corporate crime because we don't even know how much of it there is. We don't even have a systematic way of measuring how much there is. We don't have alternative ways to find out what the dark figure of crime is. We only have regulatory agency data, and how many regulatory agencies are there? We have data from the FBI, but that only captures a small piece of it. We have other data sources that we have to go and piece together. Researchers are 20 years behind the times. So, I think a good start would be to think about how we can better measure and capture the phenomenon. How can we get better data? And I'm not advocating, by the way, for a uniform crime report for corporate crime. I think that they've, they've investigated that, they think it's problematic, but I do believe that there has to be a better way to have available to researchers some kind of systematic database that allows the kind of explorations that all of the, the FBI data and all of the longitudinal data that have been collected for OJJDP and all of the data that are out there the SARP experiments. I mean, there's a lot of excellent data in a variety of different areas that are available to researchers, and I think that white collar scholars need to have similar kinds of, of access. So, I think that's a start: a systematic set of data.

**Pontell:** I would agree with what Sally said, and I would just add that if you rely on official crime data to try to measure or understand the extent of the phenomenon and costs — the true costs of the phenomenon of white collar crime — you're going to be led down the wrong path.

**Simpson:** Exactly.

**Pontell:** When we would study — if you look at official reports, for example, of the cost and relevance of crime in the savings and loan debacle, you would clearly side with the fraud minimalists, because it looks rather small. But if you, if you look at the reality, and there were other data to look at, in terms of referrals from regulatory agencies, examinations, potential frauds, the big complex frauds that underlie what was in the official data, you find that what was recorded as the official history is just a very small portion of the entire fraud. And you could talk to U.S. attorneys, you could talk to regulators, and you can talk to enforcement — any enforcement official — and they would tell you the same thing: there was literally no way to prosecute and categorize and capture all of that fraud. And so, going back to what Sally said, you really have to be creative. And it also is a very difficult turn to take, and I think it's one worth taking simply because the costs of these debacles are now so huge, and the cost of fraud in those debacles is so huge, that if we don't, we're missing a very significant portion of crime. As one example I could just tell you: all of the bank robberies in American history would not add up to the resolution cost of one medium-sized S&L during the savings and loan crisis. And we're talking about a crisis in the past, which is now very small. At that time it was unprecedented. Very small compared to what we're talking about now. So that gives you at least a handle in terms of, you know, we may not be able to measure the exact amount, but we know — there's really no confusion or debate about this — that the costs are enormous.

**Rose:** Well, thank you very much, Dr. Simpson and Dr. Pontell, for a fascinating discussion, and very timely discussion. You've given us all a lot to think about. Thanks to all of you for coming and enjoy the rest of your day.

(Applause.)
    
  
Disclaimer:
              Opinions or points of view expressed in these recordings represent those of the speakers and do not necessarily represent the official position or policies of the U.S. Department of Justice. Any commercial products and manufacturers discussed in these recordings are presented for informational purposes only and do not constitute product approval or endorsement by the U.S. Department of Justice.
  
Date Published: November 1, 2009
    
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