The ongoing epidemic of corporate crime

Even those who have little respect for the state of corporate ethics must have been surprised by the news from Volkswagen. It turns out that the largest car company in world deliberately designed software to allow its cars to deceive emissions testing in the United States.

It’s hard to envision the process that led to this outcome. Did some bright and ambitious young executive suggest to his superiors that rather than finding a way to comply with emission standards it would be cheaper to design a software program to cheat on the test? Then did executives discuss what that would involve and give a green light? And did this scheme end with the executive reporting back the success of cheating software to the CEO and the German version of Mr. Burns from “The Simpsons” rubbing his fingers together and saying, “Excellent”?

We may never know the details of how the top brass at Volkswagen thought it would be a good idea to cheat on emissions tests, but they obviously decided that the savings from going this route was worth the risk of detection and the potential punishment. And if the only punishment is a stretch of unemployment for people who have spent years in high-paying jobs, they are probably right.

The fate of the Volkswagen executives responsible for this fraud is likely to rest largely in the hands of the German legal system, but it is unlikely that they would face serious consequences if they were in the U.S. legal system. Corporate crime is rarely taken seriously, even when it results in avoidable deaths, whether they are caused by excess emissions because of Volkswagen’s decision to circumvent the law or by GM’s cover-up of faulty ignition switches or by Toyota’s cover-up of faulty floor mats that made cars accelerate.

Any discussion of corporate crime in the United States inevitably turns to the behavior of the financial industry during the housing-bubble years leading up to the 2008 financial crisis. The major firms in the industry issued fraudulent mortgages on massive basis and then sold them off to investment banks. These banks in turn threw the mortgages into mortgage-backed securities (MBS) despite knowing that they were not properly issued.

Then the bond rating agencies came in and blessed the MBS with investment grade ratings. This blessing ensured that pension funds and other investors would be willing to buy the MBS. The investment-grade ratings were issued despite the problems that analysts recognized with these securities. As one analyst at Standard and Poors’ famously joked, “we’d do a deal if it were structured by cows.” The rating agencies wanted their fees; they didn’t care if they were given investment-grade ratings to MBS that should have been rated as junk.

One of the great lost opportunities of the financial crisis was the failure to criminally prosecute the top executives of the financial companies involved in issuing and selling fraudulent mortgages, as opposed to the companies themselves. The latter action made little sense from the standpoint of trying to bring justice. After all, most of the executives who were responsible for crimes had moved on to other banks or retired as multi-millionaires. Similarly, there was likely little overlap between the shareholders who owned stock at the time of the settlements and the shareholders when the banks were profiting from fraud. It’s not clear who is being punished in this context.

The Barack Obama administration seems to have set out on a new course in this area with a memo from Justice Department instructing its attorneys to seek criminal prosecutions of corporate criminals rather than just seeking penalties against corporations. This policy would be a welcome departure from the policy that appears to have been in place Eric Holder was Attorney General and no criminal actions were brought against top executives in the financial industry.

However it is not clear how much impact this change in direction at the Justice Department will have. There is just over a year left in the Obama administration, and as journalist David Cay Johnston points out, it is not clear the Justice Department will have sufficient resources to pursue criminal prosecutions, even if the Attorney General wants to go this route.

If President Obama really wants to take a tougher stand on corporate crime, he does have another possible path. Mary Jo White, the head of the Securities and Exchange Commissions (SEC), has been extraordinarily lax in confronting the financial industry. While she herself has formerly worked as a lawyer representing several large Wall Street banks, she has also appointed several other former Wall Street executives to top positions in the SEC. Her pattern of appointments and the SEC’s lax record in going after misconduct on Wall Street provides little reason to believe that the bankers’ take the threat of law enforcement seriously.

Congress is not likely to approve a serious crime fighter as head of the SEC in the last year of the Obama administration. But if President Obama asks White to step down as chair, he could appoint one of the other already sitting commissioners to be chair. This would have the potential to turn the SEC into the law enforcement agency it is supposed to be.

Reforming the SEC will not by itself be sufficient to reverse the corporate crime epidemic, but it would be a big step in the right direction. It is important that executives in the corporate suites fear that they can suffer real consequences if they are caught breaking the law, just the like the thug who holds up a liquor store. Their crimes are far more serious.