COMMENTARY: ‘Get tough’ law enforcement needs ‘get tough’ governance, too

September 23, 2015

By Scott McCleskey, Regulatory Intelligence Expert

NEW YORK, Sept. 23, 2015 – The U.S. Justice Department’s initiative to focus on individual culpability in corporate crimes is long overdue and holds the potential, if vigorously pursued, to put teeth into efforts to enforce the law by deterring criminal activity. There are costs and perils to this approach, but the continuing litany of corporate misbehavior despite rising corporate fines suggests that other approaches have been less than effective.

To the casual observer, the change may seem insignificant – after all, a few corporate leaders have done serious time for their misdeeds. But the cases brought against them were for their individual actions, for crimes they personally committed within and against the corporations. The thrust of the new approach is that when a corporation commits a crime, it is because one or more senior executives made decisions in furtherance of that crime.

Organizations don’t make decisions, people do. Holding corporations responsible for the decisions of individuals has the perverse effect of affecting the shareholders and employees who remain, without effectively deterring malfeasance. A new focus on individual culpability would be welcome.

It all boils down to incentives. From CEO to mail clerk, employees do what the company has provided incentives for to get the next promotion, to earn the big bonus, or merely to keep their job. Goals and expectations are set and these become the measure by which the employees are judged. It is right to do so, and unavoidable. But creating incentives inevitably creates the risk that unscrupulous decisions will be made to achieve those goals.

There must also be a credible penalty for misconduct that eclipses the consequences of failing to meet goals.

So imagine yourself as a senior executive facing one of these ethical dilemmas: You need to meet aggressive goals or you will be seen as an underperformer. You could engage in shady activity that is unlikely to be detected and would help meet your goals. Since the activity is often in the gray areas, you might even get away with it if caught. If the consequences of (potential) discovery are the same as the penalty for failing to meet goals, you might as well take the risk. If instead there is the credible threat that your skullduggery will result in a lifestyle-altering personal catastrophe, you may think twice.

This is not merely a matter of law enforcement, it should also be a matter of governance. One of the principle obstacles to punishing individuals has been that much of their activity, though unethical, was not illegal: greed and stupidity aren’t crimes. But the range of unethical behavior short of a felony falls well within the purview of boards of directors. Boards should make the punishment for unethical behavior greater than the penalty for failure to meet goals. Giving a generous package to the departing miscreant provides no punishment or deterrent.

When the United Continental Holdings board forced the resignation of CEO Jeff Smisek amid a federal investigation over the airline’s relationship with the public official responsible for New York’s airports, the terms of Smisek’s departure included a payout of nearly $8 million in cash and stock, eligibility for a 2015 bonus, the keys to the company car, and lifetime “travel and parking” privileges. A legitimate question for the United board is how this package is any different from what he would have received under normal circumstances.

It must be stressed that at this point Smisek has not been convicted or even charged with a crime, and creating a direct flight from Newark to the city nearest the official’s weekend home – a focus of media reports on the investigation — may fall short of the bar needed for a criminal conviction. But the United board evidently saw enough in its internal investigation to conclude that Smisek and two senior government affairs executives had to go.

That being the case, why not make the payout contingent on the outcome of the criminal investigation? Instead, the package is paid immediately and comes with a clawback provision. But clawing the money back may well prove difficult and expensive, especially since the clawback requires a criminal conviction, and any settlement short of conviction would allow Smisek to keep the entire payout. Even if convicted, the government would likely be first in line for Smisek’s assets. It would have been far better to hang on to the payout until the results of the criminal investigation are concluded – or not reward him with a payout at all. And eligibility for a bonus in the year he is forced out for unethical behavior defies comprehension. Aside from the cash and stock, the non-monetary perks don’t pass the social media test. It seems reasonable to say “If you embarrass us by doing something bone-headed, you can pay for your own damn parking at the airport.”

The board had a choice to make with its response. They certainly did the right thing in giving Smisek the heave-ho, but by giving him such a soft landing their signal that unethical behavior is intolerable has been undercut and muted. You don’t distance yourself from someone by giving them a hug.

Will the new Justice Department approach stop corporate misbehavior? No. But when law enforcement and governance measures combine to make clear that there will be meaningful personal consequences for unethical behavior, the needle may move just that much closer to a marketplace that has regained some of the trust it has lost over the past 10 years.

(Scott McCleskey is a financial services compliance and regulation advisor with 25 years of U.S. and international experience at senior professional and executive levels. He is the author of “When Free Markets Fail: Saving the Market When It Can’t Save Itself.” The views he expresses are his own.)


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