Capitalisn’t: How Corporations Get Away with Crime

John C. Coffee: We’ve managed to take out of the criminal justice system for corporations, and really only corporations, any element of shame or humiliation.

Bethany: I’m Bethany McLean.

Phil Donahue: Did you ever have a moment of doubt about capitalism and whether greed’s a good idea?

Luigi: And I’m Luigi Zingales.

Bernie Sanders: We have socialism for the very rich, rugged individualism for the poor.

Bethany: And this is Capitalisn’t, a podcast about what is working in capitalism.

Milton Friedman: First of all, tell me, is there some society you know that doesn’t run on greed?

Luigi: And, most importantly, what isn’t.

Warren Buffett: We ought to do better by the people that get left behind. I don’t think we should kill the capitalist system in the process.

Bethany: A critical aspect of both democracy and capitalism is, of course, crime and punishment. How do we decide when rules have been broken, and what do we do to punish rule breakers? It’s no secret that something has gone badly wrong in corporate America, where the supposed punishment seemingly too often consists of an agreement not to punish the company or any individual rule breakers. So, Luigi and I invited Columbia Professor of Law John Coffee on the podcast to talk about his new book, Corporate Crime and Punishment: The Crisis of Underenforcement, in which he both diagnoses what’s gone wrong and offers some solutions.

Luigi: When you read Jesse Eisinger, who wrote a very critical book about corporate crime, he’s from ProPublica, it kind of fits the stereotype. But here, I consider you one of the key representatives of corporate law in America in one of the most prestigious institutions in corporate law. And here you are saying that the system is broken, and that corporations get away with murder, literally.

John C. Coffee: I think the system is not entirely broken, but I do think the system is being exploited. The cartel of defense counsel—former prosecutors—have very close associations with the prosecutors, and they both want to economize on effort and unnecessary expense. The deferred-prosecution agreement is very much the new norm.

Luigi: But can you help us, our listeners, who are not lawyers, and are not steeped in corporate governance, understand what exactly is a deferred-prosecution agreement?

John C. Coffee: A deferred-prosecution agreement is really a contract between the prosecutor and the corporation saying that if you will pay this fine, and if you don’t misbehave for the next two years or 18 months, we will let you withdraw the plea of guilty and erase all this from the record. You will have to sign a deferred-prosecution agreement, a statement of the facts, which said these things did happen. But that script gets carefully negotiated. You may agree that these payments were made, or these misrepresentations were made. You haven’t said who made them, and you’ve not involved anybody at a higher level of management.

Luigi: My concern is not just the deferred-prosecution agreement, because I’ve seen, for example, corruption trials in Italy against large corporations. In Italy, there is not such a thing as a deferred-prosecution agreement, but at the end of the day, you basically can’t get ahold of anybody responsible. And the answer is, somebody characterized it as a combination of the Eichmann and the Nixon defenses. Eichmann, of course, was the Nazi general who, when he was captured, said, “I was following orders.” And Nixon said, “Oh, I knew nothing that was done underneath me.” And so, in large corporations, the combination of the two creates this vacuum that, yeah, by accident in Boeing they picked somebody, but basically, nobody’s responsible.

John C. Coffee: That’s exactly right. That’s the sense in which it is broken. There are those, particularly on the right, who say, it doesn’t work, let’s eliminate corporate criminal liability and just go after individuals. But you’ll get no one then, because the only way we’re going to be able to really identify the individuals who are responsible is with very strong corporate cooperation. We have to motivate the corporation to turn the employees in. And that requires, in my judgment, making the company recognize that it’s in its interest to self-report. And to say, you don’t get a deferred-prosecution agreement unless you give us a middle- to high-ranking employee.

Let me explain how rare it is. The US Sentencing Commission found that between 2009 and 2012, not a single company got self-reporting credit. They will all adopt a compliance plan. And you can get a lot of credit off the sentence if you adopt a fairly cosmetic compliance plan, but self-reporting doesn’t happen. And that’s the test of whether you’ve cooperated in a valuable fashion—that or you turned in, identified employees who are responsible.

Bethany: I know Luigi is eager to get to some of the possible solutions to the problem, but before we go there, I wanted to pause on another facet of the issue that you mentioned, which is the rise of internal investigations. And you have a great line in your book that internal investigations are sort of analogous to the M&A business in the 1980s, in terms of the sheer amount of fees that they pay. So, just explain for our listeners, what is an internal investigation, and why is it that these are done by defense lawyers?

John C. Coffee: Often these are something that’s because the board has uncovered a scandal. Something has clearly become a scandal. It may be the press that first detected it. And the company says, “We will investigate.” You go out and hire an independent law firm that is not one of your regular counsel. It does a study, which may take a year or more, which is a wonderful period of delay. The next year, the company can say that it’s being investigated. And eventually, the law firm comes in with what might be a thousand-page report. And it will often cost well north of $10 million, which means it’s up there in the same level as the cost of merger-and-acquisition legal fees.

And the biggest law firms do this. They have very good counsel. They’re all usually ex-prosecutors or ex-SEC enforcement attorneys. And they’ll give you a fairly good investigation and they’ll decide without you knowing that there wasn’t enough reason or enough evidence here to go up and depose the CEO or the chief financial officer. Because we didn’t have any reason to go in and question them. It is pulling their punch a little as you go up the ladder, but it usually does give you much more evidence than the prosecution can get on its own.

Luigi: I actually lived through some analysis inside of a corporate board in Italy. And what I learned is that who has the gold makes the conclusion. So, if you are the guy asking for the investigation, first of all, you pick who you want. And then, two, you actually shape the questions in a way that determines the answer. What I learned by being on a board is that you should actually ignore the report. You should just look at the way the question is asked and what is not asked, because that’s the indication of what they wanted to find and what they did not want to find. And based only on the way the question is asked, you know to what extent they are hiding something and to what extent they’re not.

John C. Coffee: Put it this way. You may be right in some cases, I don’t think that’s a universal truth, but consider the position of the attorney who’s conducting this investigation. He may have been a former US attorney or former head of enforcement for the SEC. And he knows this investigation will get him paid $10 million or $20 million. What he doesn’t want is a reputation for being overzealous, pushing too hard to push the investigation north into the CEO’s office, because he wants to be hired the next time. And he wants people to say, “Yeah, we hired Jones. He did a great job for us. Worked very, hard cost a lot, but gave us just the kind of investigation we needed,” which means he wasn’t overzealous.

I would say it’d be a much better world if we could get the prosecutor to pick the counsel for this, but there’s a constitutional problem there. And I think there are ways you could negotiate that the prosecutor and the defense counsel have to agree on who conducts the study. And lawyers—and I know a lot about lawyers—are always responsive to who their clients are. And if they’re being chosen by defense counsel and the prosecutor, then they’ve got to consider the interests of both of them. And they’ve got to be a little bit more careful and balance what they do.

Bethany: I was thinking, and I’d love to hear whether or not you agree with this, that there’s another problem with internal investigations, which is that these reports may be a thousand pages long, but they are not public, unlike the testimony in a trial. And so, there becomes this sort of shadow justice system where people on the outside never get to really understand what it is that happened on the inside. And you use the phrase in your book “legal inequality,” which I think is a big problem, because it creates a cynicism in our society that goes beyond income inequality, a sense that you can buy a different outcome depending on who you are. And this shadowy part of it, the fact that these investigations never really come to light, is—

John C. Coffee: Sometimes they are public, by the way.

Bethany: Sometimes, but not always. Right?

John C. Coffee: Sometimes the CEO is already in trouble and the board wants to lay it all out on the line because they’re going to remove him. Boeing’s CEO did not survive. And I don’t think they were protecting him at the later end. But the report was done before he was removed. So, I think I would like to say that you have to make a public investigation. And I want a different counsel doing this than the counsel that’s conducting the litigation, because litigators are always thinking about sliding with the facts to protect themselves in the event there is a trial. I want someone who’s there to write sort of a legal history of what happened.

Luigi: Let’s start to actually move to solutions, because one of the things I like about your solution is to say, oh, we should have some external person, for example, appointing the investigator. My concern, in at least this part of your solution, is that you are a little bit too optimistic about the rest of the board, that if you have an independent group of board members, they’re going to behave in the interest of the corporation at large. I think that they need a lot of pushing. I remember after the scandal of Wells Fargo that the board was not doing anything until the CEO was berated on public television by Senator Warren. And after he was berated, they decided that, OK, we should throw the CEO under the bus and do something.

My question is, why not anticipate a forced turnover of all the board? Because, at the end of the day, if there is a major scandal, the board has failed in some direction. And the last thing in the world you want to do is to have in charge a person who tries to hide what you have done. You want a clean slate, and a clean slate will have a bigger interest in exposing the problems of the past.

John C. Coffee: My solution to this would be that a deferred-prosecution agreement would only be granted when the corporation either self-reported, that is, told the prosecutor before the prosecutor was hot on its trail, and came in and said, “We have a problem. Here’s what’s happened.” For that, you need a real incentive. That would be one way you can get this.

The other way is that you identify reasonably middle-level to high-ranking officers who ran the whole division, not the junior employee who just ran the conversations with one regulator on one occasion. Right now, we have a presumption. The presumption is, as long as you have a compliance plan, we’ll give you a deferred-prosecution agreement. A compliance plan can be created in 15 seconds by pushing the computer button that has your model compliance plan on it. And prosecutors don’t know how to test this. They don’t worry about whether the compliance plan is real or cosmetic.

I also want to greatly reduce the cost to the prosecution of acquiring information. And one way to do that is to generalize the bounty system, the whistleblower bounty system, that we today have only at the SEC and the IRS. If the SEC can say, anytime you give us information that starts this investigation, it’s really the critical information, you’ll get between 20 percent and 30 percent of any criminal penalty, or any fee, any penalty, that we levy on the company. That’s worked fine for the SEC. It should work also for US attorneys. People will come out of the woodwork if they think they can get 20 percent of what might be a $500 million or a $1 billion fine. And, yes, you can put ceilings on this, but starting with a presumption of about 20 percent, you will find that people will tell you exactly what they are not doing today. So, that’s one reform.

I also would tell you that agencies like the SEC are overloaded. And this is the most controversial thing that was in my book. And it’s made some people quite angry. But I think the SEC has got to be able to retain private counsel to pursue the really fact-intensive cases. If you’re going to litigate whether there was fraud here, whether that registration statement or that proxy statement, or that annual report contained fraudulent misrepresentations, that’s the kind of two-year trial that they don’t have the manpower or the time to do. You’ve got to hire a law firm whose work would be supervised by the SEC’s head of the division of enforcement. And that’s the same relationship that a corporation has with its lawyers. General Motors may have a legal department of 500 lawyers, but for the big case, they want the specialist. And they want the best trial lawyer they can find. And he will be closely watched by the general counsel or the head of litigation.

And I think the SEC has got to match that same ability to use the best people in the bar. And what that really does, so we’re clear on this, is it gets us around congressional budgetary limitations, because it doesn’t cost the taxpayer a dime. All that happens is the taxpayer has to give up some of the criminal fine—which you wouldn’t get if there was a poor counsel anyway— to the counsel who wins this case. And I also think, to give you a whole different topic, we’ve managed to take out of the criminal justice system for corporations, and really only corporations, any element of shame or humiliation.

You negotiate a deferred-prosecution agreement, and it’s like writing a corporate indenture. Fifteen lawyers are sitting in the room arguing about words, coming in with proposed changes, a rider they want here or there. And when all is done, you give it to the court, and the court has no authority to reject it. The decisions so far have said that the court must accept the prosecutors’ charging decision. You can’t say, “This is a sellout.”

What I want is a world in which we require the CEO to come into court at both this charging decision and, if there is a sentencing, at the sentencing decision, and admit that the company did this. This is the kind of shame and humiliation that will really bother that chief executive, and that, in turn, deters him. He doesn’t want to go through that again. Keep me away from that.

We have so cleaned up the process. It’s very bureaucratic. It’s this deferred-prosecution agreement. It doesn’t affect your market price at all when it’s announced. But if you add some shame into the process and make individuals come in and recognize that this statement of facts does describe what happened, and we’re ashamed about it, and if they don’t do that, there’s going to be a criminal prosecution, and then there would be a real trial with a real sentencing and the CEO required to be in the courtroom, that’s the way to reintroduce a factor that I think really does deter, shame and humiliation.

Bethany: Senator Elizabeth Warren has a slightly different solution, which is that the CEO should be liable for financial failures or illegal conduct if either involves negligence. What are the pros and cons of her idea?

John C. Coffee: You’re talking about vicarious liability. And there’s been a principle of Anglo-American criminal law for centuries that the criminal law, which is a unique level of shame, humiliation, disqualification, as well as loss of liberty, requires a minimum level of knowing recklessness. You had to at least know the possibility this was a misstatement. You had to at least expect that this was probably wrong, although you didn’t know it was truly false. So, the minimum level of what the law calls mens rea or guilty mind, the minimum level of criminal intent, was that you were aware that what you were saying was quite possibly false and you were indifferent to its truth or falsity.

Going to automatic liability . . . In the 19th century, there was vicarious liability and automatic liability in France for the publishers of newspapers. They were liable for any false statement. And you know what happened? The office boy was named the publisher. And that was an obvious response. The family owned the paper, but the office boy was made publisher. I don’t think our criminal law system . . . I think the legal community as a whole, liberal to conservative, would say pure negligence is not the basis for criminal liability.

Now, there is something called willful ignorance, which is very hard to prove. It’s rarely, rarely been. The Supreme Court has made it even harder to prove in the last decade. But I think that is a basis for holding people liable if it’s willful ignorance. With willful ignorance, you are asked in Tijuana to drive across the border and told there’s a 20-pound compartment under the rim. Don’t look at what’s in there. Don’t open it up. Well, guess what? You weren’t told it was cocaine, but you were willfully pretty ignorant if you did it.

Bethany: I just finished reading a book by a couple of Washington Post reporters called American Cartel. It’s about the role the big drug distributors played in the opioid crisis. And I wanted to go back to your notion of shame, because I love that idea. I love the idea that shame would prove a deterrent. But when I read books like this, I wonder if there’s even such a thing as shame anymore. Would we even be in some of the situations we get into, if there were such a thing as shame?

John C. Coffee: I think there is some shame when you are really being closely watched. That walk up the courthouse steps for the beginning of a trial, when there are 15 TV cameras and reporters asking you to say something—people sometimes commit suicide before that point. And that shame is burdening them. I do want to institutionalize shame and not leave it to, well, the lawyers will handle that. They will sign a deferred-prosecution agreement, and the board will certify it. No, we want to have you go into court. And the court says, “It says here that the following happened. Is that right? What do you feel about that?” And this is going to put a lot more focus on the prosecutor. A good judge, who may have been a former prosecutor, will know how to ask questions. It says you did this, and you did that. And if that goes on for two or three hours, I think you’ve got a real deterrent effect. People do not want to face that in court.

I think we have to focus not just on the CEO. I think we have to focus on the senior management team and find a penalty that can be imposed upon the group. In a serious crime case where we think there was management involvement, I would want to not only fine the company but put it on probation. And one of the conditions of probation would be to curtail, downsize, or even suspend for the probation period, the payment of incentive compensation, stock compensation. Now, we’re finally giving every manager a reason to monitor closely. If he has vague suspicions that one of his colleagues is cheating, he’s not going to rat on his colleague. He’s just not going to get himself involved in it. But if he thinks that colleague is endangering his wealth, his incentive compensation, now he’s going to take steps well before the prosecutor is involved. He’s going to go to the audit committee and say, “You’ve got to stop this. We’re all going to get in trouble.”

Now, you have created an incentive for management to cross-monitor each other, making sure no one is doing something that will affect their compensation. Now, that will also be so controversial that I don’t think we’re going to get immediate acceptance of it, but we’ve got to realize that we want management to have a group interest in avoiding the company being convicted.

Bethany: I was struck by how often, when you were talking about your proposed solutions, you used the word controversial. And so, I’m wondering if it’s fair to say that while there may be pretty broad agreement that we have a problem, when we get into the specifics of the solution, there’s a lot less agreement.

John C. Coffee: Well, again, legislation like this is so specialized. It’s going to require people knowing a lot about it. It’s easy to block something when it’s highly technical, like the tax code. And here, when you say we’re going to require this or that to get a deferred-prosecution agreement, it’s going to be a technical debate with all of the defense-bar establishment lined up against it. You only get this kind of reform after a major financial crisis. And, hopefully, we’re a couple of years away from the next major financial crisis.

Bethany: Fingers crossed.

John C. Coffee: Right now, this week, I’m not so sure.

Luigi: Thank you very much, Jack.

John C. Coffee: Thank you.

Luigi: This was great.

John C. Coffee: OK. Very good.

Luigi: Bethany, what I find most striking is that this book has been written by the blue blood of corporate governance and corporate law in America. Ten or 20 years ago, you had to have Jacobin writing a book like this. You wouldn’t find it in mainstream academia, in the mainstream media, in the mainstream anything. And I think it’s a sign, number one, of how bad the situation is, that a lot more people—and influential people—are paying attention, and they’re pushing for change.

On the details, there is some stuff that is clever and some stuff that might be a bit too clever for its own good. Maybe we should go through some of the ideas and see to what extent you think and I think they are valuable, to what extent maybe they are a little bit too clever.

Bethany: On that note of, he would not have written this book 20 or 30 years ago, the other thing that stood out to me is how much the system has changed. The rise of these things called deferred-prosecution agreements that, between 2002 and 2016, the Justice Department entered into 419 nonprosecution or deferred-prosecution arrangements with corporations versus 18 in the prior 10 years, it’s really a stunning statistic. And I think we were all loosely aware that there was a rise of these things and that corporations weren’t being prosecuted aggressively the way they were in the days of Enron. But the numbers are just striking. And I thought the other point he made that was really, really interesting was to highlight the role of internal investigations and big law firms.

I loved his analogy that internal investigations are to big law what M&A was in the 1980s, just this incredible money-making gusher, and they are. And I thought that nexus between big law and the Justice Department and corporate America, it’s really quite striking. Appalling is a better word maybe than striking, but striking.

Luigi: I have been an active researcher in this area, and I fought to establish how pervasive corporate fraud is. So, let me tell you, I have a paper. Immediately after the Enron scandal and the Arthur Andersen demise, et cetera, people paid particular attention to companies that were audited by Arthur Andersen. If you make the assumption that all the crime that was taking place in Arthur Andersen-audited companies had been detected after the fact, then you can estimate how much fraud there is in corporate America at large. And the number we came up with was basically 10 percent of large, publicly traded firms were committing securities fraud every year, with an estimated impact of $830 billion. So, this stuff is huge.

Now, as you can imagine, this paper had a long gestation, because very few journals wanted to publish it. But the good news is, it’s been accepted for publication, so it’s finally going to go in print. But it took 10 years to get it published, because I think that it’s one of those results that nobody wants to see in print, because then, of course, it’s cited all the time that this is a fact. And then it becomes difficult to say that this is an exception, that there just are a few bad apples or stuff like that.

Bethany: Well, if I’m writing my Substack by the time your paper is published, I will write a Substack about it, because I think that is fascinating. And I can’t . . . It is really telling and interesting that it took 10 years for you to get it published as well.

And it resonates with me, because I’ve thought for a long time that the fraud that gets detected is when there’s a collapse like Enron, when the company goes bankrupt, and everybody goes swarming all over the company, or at least they did in the past, to figure out what went wrong. But there’s an awful lot of earnings manipulation that could qualify as securities fraud that never comes to light, because there’s no incentive for anybody to look.

Luigi: But there are a lot of other things that are fraud that are not just earnings manipulation. One of the things that we discovered writing this paper is that you can do securities fraud for any kind of fraud that the company does. My favorite one was a company that was reselling plots in a graveyard. He was actually taking the bodies out and reselling to the newcomers.

Bethany: Ew.

Luigi: And when they were discovered, they did securities fraud.

Bethany: But on the note of earnings manipulation, I was going to say that it is really pervasive, and you can see it. I’m actually paraphrasing Andy Fastow, the former CFO of Enron here, when he gave a speech at a financial-fraud conference where I was moderating it. He pointed out that, I think it was the fall of 2018, there was a Wall Street Journal headline. And I am going to miss the exact words of the headline, but the headline said something about CFOs’ compensation increasingly tied to their hitting earnings targets. And it was a straightforward headline. There was no commentary in the piece that there was something wrong with that. And Andy said, “You can see just by looking at this how widespread earnings manipulation is in corporate America, because why on earth should a CFO’s compensation be tied to whether or not the company meets earnings targets?” That’s not the CFO’s job. The CFO’s job is supposedly, purportedly, in a better world, to be the honest broker of what those earnings actually are, not to manipulate them in order to make them meet a predetermined target.

And so, then the question of when that crosses over the line into out-and-out fraud, well, it’s usually when there’s a problem at the company, when they don’t meet earnings or when they go bankrupt. But it’s happening all the time and happening in such a pervasive way that no one even thinks it’s odd to read that a CFO’s compensation should be tied to the company’s ability to meet earnings targets. And it actually took Andy for me to see that. I’m not sure I would have. I would have read the headline and been like, “Oh.”

Luigi: But what is interesting is there is a paper written by John Graham, who is the current president of the American Finance Association, and other people, that looks at the savvier CFOs, and they ask if they’re willing to give up some economic value to smooth earnings. So, not if they manipulate earnings from an accounting point of view, but to some extent, even worse, because you can claim that the accounting manipulation is not destroying economic value. Here, they are destroying economic value. Seventy-eight percent say yes, that they’re willing to do so. That’s a pretty shocking number.

Bethany: That is a really shocking number. And it reminds me, of course, my touchstone is Enron to a great extent, but one of the shocking things about Enron and the aftermath of its collapse was this risk manual that said, essentially, corporate management is rewarded for meeting earnings-per-share targets, not for economic reality. So, risk-management strategies are oriented toward meeting earnings targets, not toward economic reality. And it seemed so shocking at the time, but basically what you just said is that a version of that mindset is widespread.

Luigi: Let’s talk about solutions, because I think that there are some solutions that are really good. Others may be less incremental. What is your favorite one?

Bethany: I like the idea of finding a way to counter the overworked nature of prosecutors, both civil and criminal, by outsourcing the work to law firms, to plaintiff’s law firms. The question I had at the end of the day was, could you ever pay those people enough? Because even if they are paid on a contingency level, if they’re successful in helping the government prosecute, I love the idea of finding a way around the fact that so many people in our government, including our prosecutors, are overworked. What I was less sure about is if the economics of it actually made sense.

Luigi: I completely agree. I think this is one of the strong points of the book. I am a little bit less enthusiastic about this idea that, oh, you create an independent committee of the board and assign them the role of doing the investigation. It’s definitely better than what it is today, but the idea that the independent committee is really independent on these things is not in the feasible set. These law firms—and I have experienced them from inside the company, so I can tell you firsthand—they’re basically trying to please the customer. And then the secret is what you ask and what you give them. And they basically don’t ask, don’t tell. That’s very hypocritical stuff, and I remember that at the board meeting, I started asking questions, saying, “Why didn’t you ask these people?” And they were all upset, because I was like the crazy guy that was saying the emperor has no clothes, because everybody knew.

I wasn’t saying anything brilliant. Everybody knew, but everybody was pretending. And I was the idiot saying, no, let’s stop pretending. And then everybody panicked because they said, “Oh, the minute somebody says on the record that these questions should have been asked, then I get in trouble. You get in trouble.” And so, immediately, I was kind of pushed out because I was breaking the equilibrium.

Bethany: I also liked his idea of getting employees to turn against each other, incentivizing whistleblowing more. I think there are two problems with it. One is that you will create full employment for lawyers, because a lot of whistleblowers are crazy. I mean, that’s their glory and their horror is that they’re crazy. They see things the way the world doesn’t. And so, if you incent this kind of internal whistleblower, you’re going to have a full-time army of lawyers in this country who are investigating whistleblowers’ claims, some percentage of which are going to turn out to be without merit.

Is that better than the alternative? Probably. Our system is full employment for good corporate lawyers anyway. So, I guess, why not do it this way? But it’s not a system without a lot of waste.

My second issue with it, which might be more debatable, is that I’m not sure a lot of people inside corporations see the crime happening in front of them. The way he’s laid it out, it posits a world in which employees inside a company are aware of crime when it’s happening. And they just have to be incentivized to report it. I think self-delusion and rationalization are really, really powerful. When I called people reporting my book about Enron, what struck me most of all was the number of people who didn’t see that there was anything wrong. And you have to remember, at Enron, there was one whistleblower, and she didn’t even come forward. When you even think about Theranos, the shocking thing, isn’t the whistleblowers who were brave and came forward. It’s that in a company with that many employees, there were only a handful of whistleblowers. And so, to me, that’s testament and proof to the fact that self-delusion is powerful. Corporate culture is powerful. And a lot of people inside a company, they can be part of a fraud and not see it as it’s happening.

Luigi: I am a big fan of whistleblower policy. In fact, I have been advocating for them since 2004, when I studied the Parmalat scandal. They falsified a 4 billion euro Cayman Islands account with paper and glue. They literally cut out the letterhead of Bank of America. They pasted it and they faxed it to the auditor. And that’s when I said, “Wait a minute, I don’t think that the CEO or the CFO did the cutting and pasting himself.” So, there was a secretary doing that. When you do something like that, you know you’re doing something that is wrong.

To your point, you are absolutely right that all whistleblowers are basically crazy by definition, because the life of a whistleblower is made miserable. And so, if you’re not crazy, you don’t do it. Actually, you have a lot of power as a whistleblower if you come forward, but you need to be protected. And that’s the reason why you need the money.

Now, the other good thing is that the qui tam statute, which is the system that prevails for the False Claims Act, is a system where you are taking a case in the name of the government. And then the government, if it’s convinced, it is going to join and will give you the reward, and if not, it is going to drop it.

And so, you are right that you delegate to the lawyers the task of sorting out the smart claims from the not-smart ones. I think that’s the best system in the world, because there are a lot of crazy claims. However, there is the fear that if you give to some centralized power the role of screening this, they’re going to screen it in the way they want with some bias. And, by the way, this is exactly what Dodd-Frank did. Instead of copying the False Claims Act, they gave the SEC the role of bringing the claims.

I was looking at a paper, watching the presentation of a paper a couple of years ago. And I said, “Wait a minute, shouldn’t we see a dramatic rise in insider-trading cases? Because now, with the Dodd-Frank law, there’s there is a reward, so the number of cases should have gone up.” And they said, “No, no, because the number of lawyers at the SEC is fixed, so the number of cases remains the same. It’s just that it’s easier for them to bring them, because there are the whistleblowers.”

That’s the problem with a centralized solution. And I agree with Jack Coffee that the reason why the Trump administration wanted to undo this is precisely because it works well. And the reason why Congress put on this extra filter is because corporations were terrified that this would work well. So, it’s completely because it works that it is not applied.

Bethany: Just to clarify, when I say crazy, what I also mean, in addition to the incredible . . . It upends someone’s life to be a whistleblower. I have a friend who was a whistleblower in the case of this company called MiMedx, and corporations try to destroy whistleblowers. And even if they have some protections under the law, if it takes three years, five years, for the case to make its way through the courts, they can be bankrupted by the corporation during that period of time. It’s really quite awful. And if anything, I would say we need some sort of protection for whistleblowers from having to pay legal fees that are caused by the corporation against whom they’re blowing the whistle, at least during the period of the case, so that people aren’t bankrupted by fees for cases that later turn out to be perfectly valid.

But there is another element to crazy that gets to my second point about self-delusion, which is that a lot of people inside a company march to the beat of the same drummer. That’s what happens when you’re inside a powerful corporate culture. And it is only the crazy people—and I mean that word in the best of senses—it’s only the crazy people who see things their own way in the face of that. And it takes that particular kind of crazy, that ability to see things differently than the rest of the world is seeing it, to be a whistleblower. And there just aren’t that many of those sorts of people. And, yes, I think it is indisputable that the law has worked well and is a good thing.

My point is, there is a fair amount of waste that goes with it, too. I think I would take the waste. I think it’s for sure better than the alternative. But there are an awful lot of cases you never hear of and an awful lot of legal fees paid by corporations to investigate whistleblowers who turn out not to have a valid case. I’ll take that waste any day, but it is not a perfect system.

Luigi: I think you are right. I would like to see the statistics. I don’t think that I’ve seen any paper documenting how many cases brought by whistleblowers, especially with the qui tam statute, are indeed frivolous, because in some cases, you might not have been able to prove the point, but it might be a true whistleblower.

You would like to see how many are frivolous, how many are too hard to prove, and how many are indeed sort of valuable. And my view is the current system of plaintiff’s lawyers is extremely risk-averse, because they are betting their firm on trying to win the case. I don’t think that they bring an excessive amount of cases. If anything, I would say too few cases. So, the idea that we see an exaggerated number . . . I am with you that if there was no filter, if we pursued every single lead, it would be crazy. I’m prepared to bet, not a lot, but to bet that we are bringing too few cases, not too many cases.

Bethany: Yeah, you’re probably right. I like the idea of the filter being the economic incentives of lawyers. And I think if you were to expand whistleblowers in the way that Jack Coffee represents, to somehow set it up such that the filter is the economic incentives of lawyers, that would be a really good filter. If it’s set up, per your point, to be the SEC or to be an internal investigation done by the company, then, no. But if it’s set up to be the economic incentives of an outside lawyer, then, yes, I think that would be fantastic.

I like the idea also that you should downsize the amount of incentive comp over a period of probation, so that everybody is in this together. One huge problem with deferred-prosecution agreements, nonprosecution agreements, this whole current setup, is that it’s shareholders who pay the fine, and corporate executives often don’t. And all you have to do is look at the banks in the wake of the financial crisis and the billions upon billions of dollars that they paid in fines while their senior executives continued to take home tens of millions of dollars. A corporation’s incentives are entirely to settle with the government, have their shareholders pay a fine, and have their executives waltz on and keep their millions. So, I love the idea that, as he said, extreme incentive compensation is criminogenic, which is a word I’m going to use more often, by the way. But I’m not sure that works in a market economy, because people will just leave.

Luigi: Actually, he responded to that criticism. I think that is a legitimate thing. But he responded to that criticism by saying that many of the executives in questionable corporations might not be so likely to find another job, because there is some stain associated with that. So—

Bethany: I don’t agree with that because, well, it depends on what industry you’re talking about. If you’re talking finance, given the huge growth since the financial crisis of the unregulated shadow-banking system, private-equity firms, hedge funds, all sorts of small-time firms dealing in debt ownership and carving up pieces of debt in various ways, there’s always some place for these people to go. And so, I’m a little bit less optimistic about that than he is. Clever financial minds can always find a place to go.

Luigi: Yeah. But then you can follow them and investigate those companies, because if they hire a crook, probably they are crook companies.

Bethany: You know what actually is amazing about that? This is a little bit of a tangent, but you know that famous line, it’s F. Scott Fitzgerald, right? “There are no second acts in American life.” That might be true everywhere but in corporate America. At least in finance, there are second acts and third acts and fourth acts. You can be a disgraced financier. You can have blown up firms over and over again. You can be a stock promoter and travel from firm to firm to firm. And you get to keep having, it’s more like a cat, you get nine lives. It’s stunning. I have a friend who runs a small hedge fund—it’s not so small anymore—but who makes a lot of money shorting stock. And he, for a while, made a ton of money just by having a database of sketchy people, who the mere mention of their name and their involvement with a company would let him know that it was a pretty good chance this company was a fraud. And no one else was doing that. They got to just keep moving on. It’s astounding.

Luigi: It is astounding. Now, one other thing that I find intriguing—I would like your opinion—is this idea of hiring the private sector on a contingent basis to do the investigation. What do you think of that?

Bethany: Yeah, I think it’s a great idea. What do you think?

Luigi: I think that—look, he discusses this in the book. There is an issue about demoralizing the staff internally. However, if you are a good but not outstanding lawyer, and you get a super big case, you bring in a super consultant for the case. This is standard in the lawyer’s world. I think that this would be a good thing on two metrics. One is because we’re going to get more convictions. But, two, one thing I learned seeing this in action in Italy, which is a small country, is you are going to create an ecosystem of firms that are not only designed to protect the incumbents. And so, they generate a literature and a demand, et cetera, for alternative views of the world.

Bethany: Any big firm that is hiring a law firm is going to look first of all to see what conflicts of interest you have, and if you’ve represented, or represented in the past, people who are adverse to them. And they’re going to look also to see what your reputation is. So, AIG for instance, used to have a panel of lawyers, of law firms, that were approved to do its work. If you weren’t on that panel, you weren’t going to get hired by AIG. In order to get on that panel, you couldn’t have done work for anyone, any company, that AIG had sued. And you couldn’t have done work for a plaintiff’s law firm. You couldn’t have opposed AIG on any previous matter. So, if you want to be on the roster of law firms approved to work with most really big companies, you have to play ball, or you’re not getting that business.

Under Jack Coffee’s proposal, you would create a cadre of law firms. And some of them might be the existing plaintiff’s law firms that would do this work for the government. But it wouldn’t be America’s big law firms. They wouldn’t be able to do that and keep their corporate clients. And they wouldn’t be able to do it for another reason, too. America’s big law firms are still primarily paid by the hour. They’ve resisted any move to contingency payments. Some of them are being forced, kicking and screaming, into more contingency-fee arrangements. But the only law firms that do contingency-fee arrangements are the plaintiff’s law firms. So, you would create an entire cadre of firms that did this work on behalf of the government. And they might be very, very good. Some of the plaintiff’s law firms that are paid on a contingency basis are very, very good. So, I’m not saying the quality wouldn’t be there, but you wouldn’t get America’s big law firms, the Kirkland & Ellises, the Cravaths, they’re not going to do that work.

Luigi: Sorry. I didn’t want to say that. My idea is, because you have two strong poles, then you’re going to have a much healthier debate, even at the legislative level, et cetera, because you have two conflicting interests. Today, you have a David and a Goliath. And when it comes to political discussion, et cetera, the Goliath will always win.

Bethany: I think that’s not a hundred percent true. And I absolutely hear what you were saying, and I don’t disagree. I was just tossing up some additional thoughts and some caveats. I’m still not sure it’s really a David and Goliath. And I did like one thing that Jack Coffee said, which was to have the Justice Department move against you, even if you are a wealthy corporate executive, is still incredibly destabilizing and changes your life forever. And I don’t think it’s quite David and Goliath. I don’t think it’s a light experience for anybody on the other side of that. And I liked that he was nuanced about that.

Luigi: Sorry, I thought that David and Goliath is the discussion in academia about the legislative phase, when you have two different interests, and one interest is very well supported and fed, and the other is not. I agree with you that there is a power to the government. And, to this extent, I have a little bit of a mixed feeling of his view of shaming. I even myself wrote about the importance of shaming in my book. But I am nervous about overusing it, because as you said, it can be devastating. And I remember that in Italy, when the judiciary went very aggressively against corruption, there were a couple of executives that committed suicide in jail. And one committed suicide just before being arrested. And in some cases, you’re not even sure that the guy is guilty, because this takes place before. Much of the shaming takes place before the official conviction. And so, I think that’s, to me, a little bit dangerous.

Bethany: I think it is, too, because it approaches mob justice. And we’ve already had a great example of this, which were the insider-trading cases brought in, when was it, 2014, 2013, by the Southern District of New York, when Preet Bharara was the US attorney there, and the government, the Southern District, and the FBI used shaming in those cases. I remember talking to one guy who was arrested for insider trading, and he had offered to go to a hotel so that the FBI could come and pick him up at the hotel. And instead, they insisted on storming down his front door with the press in tow, with their cameras, with his children crying at the door while he was arrested. And his case was later overturned. And so, it’s a dangerous tool to encourage, because it allows for the abuse of power on the front end, without any accountability on the back end.

I mean, those FBI agents in the Southern District never had to say, “I’m sorry” to this guy. So, I am a little skeptical about that tool, too. And I also worry that the very people who need to feel shame the most are impervious to it anyway. In other words, the people who are going to feel shame are the ones who probably wouldn’t be in this situation and maybe haven’t done anything wrong. And the ones who have really done something wrong are probably pretty impervious to shame. So, I was a little worried about that as well.

The Supreme Court has been in the headlines for the last bunch of weeks, for obvious reasons. Luigi and I thought for this week’s capital-is, capitalisn’t, we would look at the Court’s majority 6-3 decision in West Virginia vs EPA.

Speaker 8: The Supreme Court capped off a week of landmark decisions yesterday by limiting the EPA’s power to curb carbon-dioxide emissions.

Bethany: Is the Court’s move a capital-is, or is it a capitalisn’t?

Speaker 8: By a 6-3 vote, the Court ruled the Clean Air Act, first established in 1963, does not give the environmental agency the authority to regulate greenhouse gases from power plants that contribute to global warming.

Bethany: The question in some ways was technical in nature. It was whether the Environmental Protection Agency has the authority to impose caps on carbon emissions by mandating a shift to cleaner energy sources. But it goes to a much bigger issue, which is this: just how much power should regulators have?

Speaker 8: Writing for the conservative majority, Chief Justice John Roberts conceded that even though regulating a transition away from coal would be a “sensible solution to the crisis of the day, the EPA does not have the authority to do that.”

Bethany: Luigi, what do you think about the issue?

Luigi: Actually, I’m very torn, because I first read a number of commentaries, and maybe because I’m a contrarian, but when I read a number of commentaries, I ended up agreeing more with the Supreme Court than I expected. And then I read the Kagan dissenting opinion, and that actually changed my mind. So, let me try to explain why I have these mixed feelings. Because, on the one hand, I think if the principle is, should the Supreme Court limit the power-grabbing that agencies do and make sure that we are subject to laws approved by parliament, I think that’s, to me, a very good idea. Now, I might not like the outcome in this particular case, but I try to always think about what the alternative is, and would I like the inversion of the decision if the topic were a different one? I am afraid of decisions that are not made by parliament. I think that important decisions should be made by parliament. And, of course, agencies have their role implementing those decisions, but not in driving those decisions.

Bethany: I think you’ve been in Europe for too long. Congress, not parliament.

Luigi: That’s true. But actually, the difference is, in Europe, the parliament does work, and the Congress doesn’t. So that’s the reason why I use the term parliament, because you are assuming that this stuff works. But many of the criticisms I see that left me cold is to say, oh, but because Congress doesn’t work, then we should do something else. And I don’t buy this line, because if I start saying, oh, but because this does not work, I’m justified to violate or to deviate on the other dimension, then we pretty quickly escalate. At this level of abstraction, I’m actually in favor of the Supreme Court decision.

Then I read Kagan’s dissenting decision and I realized that, number one, the Court did not have to decide on this issue. The rules were so kind of middle of the road, that by the time they were litigated, et cetera, everybody had complied, and so they were moot. And so, there was no reason for the Supreme Court to intervene, except if the Supreme Court wanted to basically change policy, which is, to some extent, the opposite of what the decision is about. Because, certainly, you don’t want to leave the power to the Supreme Court to make policy. And this Court has been arguing against, judicial interventionism. But they do judicial interventionism in a major way, because the tradition should be, if I don’t need to state an opinion, I should not state an opinion. So, that’s point number one.

Point number two, and here we’re going into many technical details that I am not privy to, but from what I read in the dissenting opinion, Section 112 of the EPA Act, which is the matter of contention, broadly authorized the EPA to select the best system of emissions reduction in every case, including the power plants. So, it’s not under discussion . . . Even the Supreme Court did not challenge the ability of the EPA to set limits on gas emissions. It’s not like saying, “Oh, the EPA was designed in 1970, when greenhouse gases were not an issue. And so, they have no power to rule over those." Apparently, the Supreme Court did not intervene on this topic. So, we should have worked under the presumption that they do have the power to intervene on greenhouse gases.

Now, this said, the question is, are they exceeding the power stated by Congress? And if Congress gave them the power, they can select the best system of emissions reduction, then they can, period.

The argument on the other side is the so-called major questions doctrine, which says that if you are making such a large decision that changes the life of people, it must be authorized by Congress. But this is a Supreme Court doctrine that can be argued one way or another. It’s not that compelling to me as initially it was.

Bethany: So, I seconded your thinking most of the way through. I thought the same thing, except I actually ended up in the same place, which is that when I first delved into this, I expected to say what most people I know are saying, which is how absolutely horrible, the Supreme Court is beyond terrible. And I thought, actually, in this case, I agree. I came at it from a slightly different perspective than you did, which is that a lot of what we’ve talked about on this podcast has been that it is very much a capital-is to have ground rules in place for how capitalism functions. Simply foundational to a “free market” are rules. And the fact that the rules are foundational to the free market isn’t acknowledged as much.

At first, I came at this thinking, no, no, no, you need an EPA to be able to set rules that apply to everybody. That’s the way this has to work. There’s no such thing as an unfettered free market. But then I actually came away from reading all of this thinking that, no, this is Congress’ job. And the fact that we have a dysfunctional Congress doesn’t make it OK for Congress to be dysfunctional. Per your point, if you start saying we have a dysfunctional Congress, therefore we need other people, other institutions, to step up and do what Congress won’t do, whether it’s the Federal Reserve or whether it’s the EPA, I don’t think we should give Congress the right to be dysfunctional. This struck me in Kagan’s dissent where she said, “The Court appoints itself, instead of Congress or the expert agency, the decision-maker on climate policy. I cannot think of many things more frightening.”

If that were true, I would agree. That’s really, really frightening. But I don’t think that’s what the Court is saying. I think they’re saying, no, Congress is the decision-maker on climate policy. You want these rules? Congress, you pass these rules. Per your point about the Supreme Court not having to intervene on this, that they chose this, they chose to get involved here, that’s what they do. When they see a case that then can set precedent more broadly, they seize that case. And, yes, this is a Court that is looking for cases on all sorts of issues, including this one. So, it doesn’t trouble me so much that they intervened in a case that they didn’t have to step into. That’s what the Court does as a matter of course, is to look for seemingly minor cases that can set a broader precedent.

The part of this that troubles me the most is actually all the extracurricular stuff that went into the rulings. The Times, in particular, and The Intercept have done a couple of really good pieces, just pointing out the years of lobbying and the appointments of judges, such that you ended up with basically a handpicked court overhearing this case. And that is upsetting to me. I think that goes to a broader issue of money in politics. And so, I don’t like the way in which this came about, and that’s the piece of it that I find really troubling. But I’m not sure I disagree with the decision itself. In fact, I don’t think I do. I think Congress should be doing this.

Oh, and then the other piece of this that the howlers have not dealt with is the market. It’s also for the market to say, we’re not going to finance a coal-fired plant. We’re not going to finance the plant that has a certain level of emissions, because we don’t want to do this. And the market is already doing that. And so, I think that some of the hysteria about this ruling may overstate the effects of it, because there’s already a fair amount of market discipline around on this issue.

Luigi: I think, Bethany, what we disagree about is not the principle that Congress should rule on this issue. It’s whether Congress has already ruled on this issue or not. And this is, I have to admit, I read the opinion. I am not a lawyer. I’ve not done all the study that we need, but reading the opinion, in 1970 Congress said that the goal of the EPA was to speed up, expand, and intensify the war against air pollution, and it gave the EPA the power to select the best system of emissions reduction. So, the issue is not that we want to let the EPA decide where it does not have authority. The issue is the EPA seems to have the authority, and this Supreme Court decided to take it out, introducing a new kind of criteria that is this criterion of the major questions doctrine. And I think that this is what I find troublesome.

Bethany: Yeah. I hear you on that front. I don’t understand enough of the history to know if I agree that Congress already does have that authority. But, for sure, if Congress disagrees, if our elected representatives disagree with what just happened here, then pass a law. And don’t just hide behind these omnibus spending bills. And don’t hide behind, the dysfunctional Congress can’t get anything done. Pass a law. Say it again. Say it explicitly. Overrule the Supreme Court by saying, this is explicitly what we’re going to do here. And I would have no problem with that. Those are elected representatives who can then be not elected again in their next term, unlike regulators or the Supreme Court, who don’t stand for election. I think this is on Congress to fix it.

Luigi: I agree, but if you have a Supreme Court that strikes down all the laws that Congress makes in one direction, but not in the other, then you don’t have a fair system.

Bethany: Well, for sure. And if that’s where this is heading, if this is a broader attempt to strike down laws that Congress has actually made, and there isn’t some real debate on this issue—and again, I don’t know, I think there might be more debate on this than you’re giving it credit for, as to how much power the EPA actually has. If this is the beginning and the Supreme Court is actually going to strike down laws that Congress has made, that’s incredibly troubling, and I would agree in that case, it’s a capital-isn’t.

Luigi: Okay. So, we disagree on a matter that both of us know very little about, so we need to call on the show a couple of legal experts. And, of course, depending on their political views, the legal experts will be completely convinced of one or the other interpretation.

Bethany: Exactly. And that’s precisely the problem. Matters of law are still matters of language. And the interpretation of that language can be, in the end, political, even when you think on the surface it should be anything but, it should be clear cut.

But we’re going to find out. I mean, this is obviously an incredibly activist Court. And if this is the beginning of the Court overturning the clear intent of Congress on various issues, then I actually think the country is in trouble. I think that is a huge, profound, deep, dark issue if that’s true.