[Senate Hearing 107-923]
[From the U.S. Government Publishing Office]
S. Hrg. 107-923
PENALTIES FOR WHITE COLLAR CRIME
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HEARINGS
before the
SUBCOMMITTEE ON CRIME AND DRUGS
of the
COMMITTEE ON THE JUDICIARY
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
SECOND SESSION
__________
JUNE 19, JULY 10, AND JULY 24, 2002
__________
Serial No. J-107-87
__________
Printed for the use of the Committee on the Judiciary
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WASHINGTON : 2003
____________________________________________________________________________
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COMMITTEE ON THE JUDICIARY
PATRICK J. LEAHY, Vermont, Chairman
EDWARD M. KENNEDY, Massachusetts ORRIN G. HATCH, Utah
JOSEPH R. BIDEN, Jr., Delaware STROM THURMOND, South Carolina
HERBERT KOHL, Wisconsin CHARLES E. GRASSLEY, Iowa
DIANNE FEINSTEIN, California ARLEN SPECTER, Pennsylvania
RUSSELL D. FEINGOLD, Wisconsin JON KYL, Arizona
CHARLES E. SCHUMER, New York MIKE DeWINE, Ohio
RICHARD J. DURBIN, Illinois JEFF SESSIONS, Alabama
MARIA CANTWELL, Washington SAM BROWNBACK, Kansas
JOHN EDWARDS, North Carolina MITCH McCONNELL, Kentucky
Bruce A. Cohen, Majority Chief Counsel and Staff Director
Sharon Prost, Minority Chief Counsel
Makan Delrahim, Minority Staff Director
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Subcommittee on Crime and Drugs
JOSEPH R. BIDEN, Jr., Delaware, Chairman
PATRICK J. LEAHY, Vermont CHARLES E. GRASSLEY, Iowa
DIANNE FEINSTEIN, California ORRIN G. HATCH, Utah
HERBERT KOHL, Wisconsin MIKE DeWINE, Ohio
RICHARD J. DURBIN, Illinois JEFF SESSIONS, Alabama
MARIA CANTWELL, Washington SAM BROWNBACK, Kansas
JOHN EDWARDS, North Carolina MITCH McCONNELL, Kentucky
George Ellard, Majority Chief Counsel
Rita Lari, Minority Chief Counsel
C O N T E N T S
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WEDNESDAY, JUNE 19, 2002
STATEMENTS OF COMMITTEE MEMBERS
Page
Biden, Hon. Joseph R., Jr., a U.S. Senator from the State of
Delaware....................................................... 1
Grassley, Hon. Charles E., a U.S. Senator from the State of Iowa,
prepared statement............................................. 129
Hatch, Hon. Orrin G., a U.S. Senator from the State of Utah,
prepared statement............................................. 135
Leahy, Hon. Patrick J., a U.S. Senator from the State of Vermont,
prepared statement and attachments............................. 136
WITNESSES
Bowman, Frank O., III, Associate Professor of Law, Indiana
University School of Law, Indianapolis, Indiana................ 23
Comey, Hon. James B., Jr., United States Attorney, Southern
District of New York, New York, New York....................... 18
Deputy, Howard, Smyrna, Delaware................................. 12
Farmer, Janice, Orlando, Florida, accompanied by Jeffrey Farmer.. 9
Gainer, Hon. Glen B., III, West Virginia State Auditor, and
Chairman, National White Collar Crime Center, Morgantown, West
Virginia....................................................... 20
Prestwood, Charles, Conroe, Texas................................ 5
Rosenzweig, Paul, Senior Legal Research Fellow, Center for Legal
and Judicial Studies, Heritage Foundation, Washington, D.C..... 26
Skolnik, Hon. Bradley W., Indiana Securities Commissioner, and
Chairman, Enforcement Section, North American Securities
Administrators Association, Inc., Washington, D.C.............. 21
QUESTIONS AND ANSWERS
Responses of Mr. Bowman to questions submitted by Senators Biden
and Grassley................................................... 42
Responses of Mr. Comey to questions submitted by Senators Biden
and Grassley................................................... 46
Responses of Mr. Gainer to questions submitted by Senators Biden
and Grassley................................................... 62
Responses of Mr. Rosenzweig to questions submitted by Senators
Biden and Grassley............................................. 69
Responses of Mr. Skolnik to questions submitted by Senators Biden
and Grassley................................................... 75
SUBMISSIONS FOR THE RECORD
Bowman, Frank O., III, Associate Professor of Law, Indiana
University School of Law, Indianapolis, Indiana, prepared
statement...................................................... 79
Breaux, Hon. John, a U.S. Senator from the State of Louisiana,
statement...................................................... 95
Comey, Hon. James B., Jr., United States Attorney, Southern
District of New York, New York, New York, prepared statement... 101
Farmer, Janice, Orlando, Florida, accompanied by Jeffrey Farmer,
prepared statement............................................. 119
Gainer, Hon. Glen B., III, West Virginia State Auditor, and
Chairman, National White Collar Crime Center, Morgantown, West
Virginia, prepared statement................................... 121
Prestwood, Charles, Conroe, Texas, prepared statement............ 142
Rosenzweig, Paul, Senior Legal Research Fellow, Center for Legal
and Judicial Studies, Heritage Foundation, Washington, D.C.,
prepared statement............................................. 144
Skolnik, Hon. Bradley W., Indiana Securities Commissioner, and
Chairman, Enforcement Section, North American Securities
Administrators Association, Inc., Washington, D.C., prepared
statement and attachments...................................... 156
WEDNESDAY, JULY 10, 2002
STATEMENTS OF COMMITTEE MEMBERS
Biden, Hon. Joseph R., Jr., a U.S. Senator from the State of
Delaware....................................................... 163
Grassley, Hon. Charles E., a U.S. Senator from the State of Iowa. 165
prepared statement........................................... 253
Hatch, Hon. Orrin G., a U.S. Senator from the State of Utah,
prepared statement............................................. 260
Leahy, Hon. Patrick J., a U.S. Senator from the State of Vermont,
prepared statement............................................. 261
Sessions, Hon. Jeff, a U.S. Senator from the State of Alabama.... 176
WITNESSES
Chertoff, Michael, Assistant Attorney General, Criminal Division,
Department of Justice, Washington, D.C. and William W. Mercer,
United States Attorney for the District of Montana and
Chairman, Attorney General's Advisory Committee, Subcommittee
on Sentencing, Billings, Montana............................... 167
Coffee, John C., Jr., Adolf A. Berle Professor of Law, Columbia
University School of Law, New York, New York................... 180
Devine, Tom, Legal Director, Government Accountability Project,
Washington, D.C................................................ 191
Donaldson, Thomas, Mark O. Winkelman Professor, Wharton School,
University of Pennsylvania, Philadelphia, Pennsylvania......... 185
Elson, Charles M., Edgar S. Woolard, Jr. Professor of Corporate
Governance, and Director, Center for Corporate Governance,
University of Delaware, Newark, Delaware....................... 187
Terwilliger, George J., III, White and Case, LLP, Washington,
D.C............................................................ 188
SUBMISSIONS FOR THE RECORD
Biden, Hon. Joseph R., Jr., a U.S. Senator from the State of
Delaware, statement............................................ 216
Chertoff, Michael, Assistant Attorney General, Criminal Division,
Department of Justice, Washington, D.C. and William W. Mercer,
United States Attorney for the District of Montana and
Chairman, Attorney General's Advisory Committee, Subcommittee
on Sentencing, Billings, Montana, prepared statement........... 218
Coffee, John C., Jr., Adolf A. Berle Professor of Law, Columbia
University School of Law, New York, New York, prepared
statement...................................................... 227
Devine, Tom, Legal Director, Government Accountability Project,
Washington, D.C., prepared statement........................... 237
Donaldson, Thomas, Mark O. Winkelman Professor, Wharton School,
University of Pennsylvania, Philadelphia, Pennsylvania,
prepared statement............................................. 243
Terwilliger, George J., III, White and Case, LLP, Washington,
D.C., prepared statement....................................... 265
WEDNESDAY, JULY 24, 2002
STATEMENTS OF COMMITTEE MEMBERS
Biden, Hon. Joseph R., Jr., a U.S. Senator from the State of
Delaware....................................................... 273
Grassley, Hon. Charles E., a U.S. Senator from the State of Iowa,
prepared statement............................................. 304
Hatch, Hon. Orrin G., a U.S. Senator from the State of Utah,
prepared statement............................................. 309
WITNESSES
Doty, James R., former General Counsel, Securities and Exchange
Commission, and Partner, Baker Botts, LLP, Washington, D.C..... 282
Hills, Roderick M., former Chairman, Securities and Exchange
Commission, and Chairman, Hills Enterprises Limited,
Washington, D.C................................................ 280
Miller, G. William, former Secretary of the Treasury, former
Chairman of the Federal Reserve Board, and Chairman, G. William
Miller & Co., Inc., Washington, D.C............................ 276
SUBMISSIONS FOR THE RECORD
Doty, James R., former General Counsel, Securities and Exchange
Commission, and Partner, Baker Botts, LLP, Washington, D.C.,
prepared statement............................................. 298
Hills, Roderick M., former Chairman, Securities and Exchange
Commission, and Chairman, Hills Enterprises Limited,
Washington, D.C., prepared statement........................... 310
Miller, G. William, former Secretary of the Treasury, former
Chairman of the Federal Reserve Board, and Chairman, G. William
Miller & Co., Inc., Washington, D.C., prepared statement....... 327
PENALTIES FOR WHITE COLLAR CRIME OFFENSES: ARE WE REALLY GETTING TOUGH
ON CRIME?
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WEDNESDAY, JUNE 19, 2002
United States Senate,
Subcommittee on Crime and Drugs,
Committee on the Judiciary,
Washington, D.C.
The Subcommittee met, pursuant to notice, at 10:44 a.m., in
room SD-226, Dirksen Senate Office Building, Hon. Joseph R.
Biden, Jr., Chairman of the Subcommittee, presiding.
Present: Senator Biden.
OPENING STATEMENT OF HON. JOSEPH R. BIDEN, JR., A U.S. SENATOR
FROM THE STATE OF DELAWARE
Chairman Biden. The Subcommittee will come to order,
please. I welcome you all, particularly our witnesses, today.
By way of brief introduction, Senator Grassley is on his
way. He is at another Committee at the moment. He has a keen
interest in the subject we are about to discuss this morning.
I would like to sort of lay out in a very brief opening
statement what we are about this morning, what I am trying to
do, why I am holding this hearing, and why Senator Grassley and
I have the interest we have.
To state the obvious, there is not a single member of the
United States Congress who does not have his or her
constituents upset about not merely Enron but what is raised as
a consequence of Enron--the loss of pensions, the loss of their
security, and in a sense, in the minds of many, the loss of
everything they have built in their whole lives, and what can
we do about that.
There is also a larger issue. When I was Chairman of the
full Judiciary Committee for years, and the ranking member for
even longer, I spent a lot of time dealing with the criminal
justice system and am responsible for or to blame for much of
the criminal law that has been written since 1978 in the United
States Congress.
One of the things that we know is that white collar crime
can be equally as devastating as other types of crime. We also
know, though, that it is much more difficult for prosecutors to
bring white collar crime cases. The fact of the matter is we
are very, very concerned, and first and foremost concerned
about violent crime in America. But when we get beyond violent
crime, we sometimes tend to lose the differentiation that is
needed between the impact of white collar crime and simple
theft.
All you have to do in any society is look at their criminal
code and it will tell you what they value and it will tell you
how highly they value it. In America, we value life more than
anything else, so obviously if someone wrongfully takes another
person's life, maliciously and with premeditation takes someone
else's life, we have the death penalty in most places for that.
Evidence the fact we hold that as the highest value--human
life.
If a women is raped, we hold that as a very high value in
most States and we say there will be a severe penalty for that.
If someone were to sneak into your house and steal $5,000, it
is less of a penalty than if someone accosts you in the street
at gunpoint and takes $5,000, because they have put you in fear
and we value our right to be free of fear. So we have a higher
penalty for robbery than we do for burglary.
Now, I know this is self-evident when I say it, but I think
sometimes we forget it. But the strange thing is when it comes
to those who rob us with a pen, rob us with a pencil, rob us
with their financial shenanigans, or they steal from us, to be
more precise, they tend to go to jail less than someone who
would steal the same amount of money from us in a circumstance
where they broke into our house.
The person who breaks into our house and steals $50,000
from us, or if they could steal our future by stealing our
pension, should go to jail for a long, long time. Yet, white
collar crime in most States and in the Federal Government
generally does not carry the same penalty.
A very slight digression. There are those who are concerned
in the corporate community with the notion of we shouldn't have
tort reform because stockholders should not be held accountable
for the misdeeds of their companies in a way that causes
hundreds of millions of dollars in damages.
Well, I would suggest that we can have it one of two ways.
You can have the tort system the way it is or a criminal system
where we lock those guys up who make those mistakes; no
fiduciary burden placed upon any stockholder, but the man or
woman goes to jail. Kind of a good idea, for you folks with bow
ties on out there. It is a good idea for you all to think
about, all those of you, like me, in suits that cost more than
$100 who are sitting out front.
The second point I want to make here is that this is about
values. So our Criminal Code, which I have not been the
custodian of, but as one who has been an overseer of for some
time, 30 years in the United States Senate, I think has to be
adjusted, or we should consider whether it needs to be adjusted
to reflect what we value. That is what this hearing is about.
Now, I want to make it clear. Our first panel here are
people who, in varying degrees, have had their future stolen
from them, not merely their money, their future stolen from
them. One of the witnesses is a person who is not sure what has
been denied him, but let me make it clear there is no proof of
any criminal activity or intent on the part of either the
companies whose pensions have gone up in smoke for their
employees, either Metachem, which Mr. Deputy worked for, or
Enron for our two other witnesses.
The reason for the first panel--and it goes back to this
value piece--is for us to understand what the damages are to
people who have lost their pension, if there later is proof
that there was a criminal intent related to their loss. It is a
different standard if there is negligence, and that is a
different issue. That is the civil system.
So I want to make it clear that by having the three people
we have here today, the purpose is not to make a case that
either Enron or Metachem or any other corporation has, in fact,
violated criminal law. They may have. I don't know, but that is
not the premise upon which you have been invited here.
You have been invited here, just as we would and have
invited victims of rape, victims of burglary, victims of
robbery, victims of senior fraud, to explain to us what the
consequences of losing your future, if you will, has meant to
you.
Now, one other point. We are going to have a series of
experts to follow this panel, and I am looking to them to tell
me if this discrepancy or the difference between the penalties
that flow from white collar crime generically and other crime
generically should remain, to the extent they exist. And if
they exist and they shouldn't remain, why do they exist in the
first place?
We have to look at this. We have to look at whether the
reason why there are not more prosecutions for white collar
crime is because it is much more difficult. By the way, it is
much more difficult. Do we have enough trained prosecutors to
be able to handle these very complicated cases?
If it turns out that we should, in fact, be pursuing more
white collar criminals and we are not and we agree that we
should, then we have to figure out why we are not. If one of
the reasons we are not is we don't have sufficient resources,
we don't have enough prosecutors, we don't have enough judges,
whatever it happens to be, then we should remedy that. That is
my job, that is the job of the people up here.
Lastly, I would point out that there has been, in my view,
some progress made by the Sentencing Commission. I am often
reminded that the reason it exists is I wrote the law setting
it up, and so those who dislike it very much usually remind me
of that. But I think they have done a good thing here. I am not
sure, quite frankly, and I am going to ask the second panel, if
they have gone far enough.
In the past, the way we have dealt with the calculation of
a loss is the penalty would flow from the calculation. You
steal one dollar, the penalty is less than if you steal one
million dollars. The way we have calculated the loss in the
past has been different than is now being proposed.
In the past, the way in which we have operated is that loss
not only measures the harm wrought, but also an acceptable
proxy for the defendant's state of mind. Stealing more is worse
than stealing less not only because it inflicts greater harm,
but also because the defendant who steals more is often thought
to have a more reprehensible state of mind than the defendant
who steals little.
The new guidelines incorporate a much better definition of
loss that takes into account the amount of harm caused by the
conduct. Actual loss now means, quote, ``The reasonably
foreseeable pecuniary harm that resulted from the offense.''
This definition, in my view, strikes the right balance between
the objective ``but for'' standard and the subjective inquiry
into the defendant's intentions.
But it still leaves some questions, in my view. The
commission determined that loss should be reduced by the money
returned, the fair market value of the property returned and
the services returned by the defendant. With respect to
investment fraud cases, the new guidelines provide that ``loss
shall not be reduced by the money or value of the property
transferred to any individual investor in the scheme in excess
of the investor's principal investment.'' Well, I am not sure
that should be the standard, but I want to discuss that.
So we are going to essentially bifurcate this hearing.
Again, the first part of the hearing relates to examples of the
impact of loss of an instrument and/or a thing of value because
of fraud. So today we want to hear from the witnesses as to
what they know the impact has been on their lives.
I am delighted to introduce Charles Prestwood, who has
traveled quite a ways from Texas to join us here today. Mr.
Prestwood spent 33 \1/2\ years at the Bammel, Texas, gas
storage facility, which later became part of Enron, working his
way up from Maintenance to Operations.
Generally he would work 12-hour shifts, commuting 75-mile
round-trips from his home in Conroe, Texas. Having been very
proud to be part of building Enron into a powerful corporation,
with the encouragement of the company's top brass he invested
an abundance of his earnings in Enron stock, amassing at its
peak $1.3 million worth of worth.
Like other employees, he was prevented from selling his
investments when the company stock value dropped last fall, and
in the end his savings dwindled to a mere $8,000. Not only will
he not be able to spend his retirement traveling, as he had
dreamed, but he now lives in fear that if the furnace or the
microwave breaks down, it is a cost and it is serious.
Ms. Farmer, thank you for traveling from Florida to join us
today. Your son is with you. I indicated to you I know we don't
salute sergeants, but since they run the show, we show them
great respect
Sergeant, it is a delight to have you here, and it looks
like you have someone looking out for you, mom.
Janice Farmer spent 16 years working to build the Enron
Corporation, spending the bulk of her tenure in the Right-of-
Way Department. After having been encouraged throughout her
career to invest in Enron stock, she was prevented from selling
her holdings, as well, as the market value plummeted. In turn,
she saw her savings drop from $700,000 to $4,000.
Is that correct? Why don't you speak up and tell me what it
is?
Ms. Farmer. Twenty.
Chairman Biden. Twenty. I am sorry. I devalued your stock
even more. I am sorry.
While she once dreamed of using her savings to take her
children and grandchildren on trips around the globe, she is
now at home and that dream is somewhat distant now.
Accompanying her is her son, Jeffrey, a criminal investigator
in the Marine Corps. Today, by the way, is his birthday and I
wish him a happy birthday.
While I regret the circumstances that brought you both
here, I want to thank you for joining us.
From my home State, I am pleased to welcome Mr. Howard
Deputy. He hails from the State of Delaware. He lives in
Smyrna, Delaware, and he has worked as a welder and crane
operator for Metachem, before the buyout of Standard Chlorine
11 years ago.
When Metachem announced bankruptcy only weeks ago, he lost
a portion of his pension, as did more than 100 union and non-
union employees. The employees' loss totaled more than
$300,000. I understand that employees and management are
currently negotiating and hopefully a settlement of these
claims will come forward, but Mr. Deputy joins us today to
share his story.
I welcome all of you. Thank you for your willingness to
share your stories with us. Also, by the way, accompanying Mr.
Deputy is Jeff James, of Middletown, Delaware, and he also
worked for Metachem for 14 years.
Again, for the record, there is no evidence, there is no
proof, there has been no case made, there has been no decision
made by any criminal court that either of the corporations
mentioned here has engaged in criminal activity or violated the
criminal law.
So let me begin now with you, Mr. Prestwood, and I welcome
your testimony.
STATEMENT OF CHARLES PRESTWOOD, CONROE, TEXAS
Mr. Prestwood. Thank you, Mr. Chairman, for having the
opportunity to appear before in front of your Committee.
Like you stated a while ago about the things that have
really happened in our lives, we have had a 180-degree
turnaround in our lives.
Chairman Biden. I hate to ask you to do this. As modern as
this place is supposed to be, we are the most antiquated
institution in the world. Can you pull that microphone--you
have got to bring it right up to your mouth because people in
the back are straining to hear what you have to say. If you
could just lean into it just like I do, if you would.
Mr. Prestwood. Is that better?
Chairman Biden. That is it; you have got it.
Mr. Prestwood. All right, sir.
Chairman Biden. And those Texans back there understand you.
Those folks from Massachusetts may need a translator.
Please proceed.
Mr. Prestwood. Thank you, sir.
Like you stated a while ago about what kind of effect is
this having on us, it is a tremendous effect. In other words,
it is 180 degrees. It is a complete turnaround because when I
retired from Enron on October 1, 2000, I had plans on doing
some traveling, my fiancee and I, and we had plans of doing a
lot of things, see some of this good old beautiful USA.
But since everything happened the way it did at Enron, I do
good to stay home, and it is awful expensive even to stay home.
I didn't have to worry if a refrigerator or water well pump or
something like that went. I didn't have to worry about that
because I had some money to back it up and I could replace it.
Now, it is my prayer everyday that everything will hang in
there until I can get better financially if I sell a little
piece of property that I own or something and kind of tie over
my house note and one thing and another.
When you think about the mental end of it, that is where it
really hurts you. When you go to bed at night knowing what you
did have and you go to bed now knowing what you don't have, in
other words, it makes you real thankful for the things that you
do have. In other words, we just went back in time. There is no
other way around it. We just went back in time because our
lifestyle has completely changed and the stock that we had is
worthless now.
The word ``loyalty''--right now, I do have two definitions
of that word. The one that I lived by for 33 \1/2\ years kind
of left me hanging out on a limb when I found out that the real
true definition of it wasn't exactly what I was thinking.
There is one little article here I would like to read and
it is in the testimony here.
``Simply stunning. That is how Chief Executive Officer Jeff
Skilling described Enron's strong financial and operating
performance in 2000. Every major business--pipelines, wholesale
services, retail and broadband--turned in strong performances
for the year that were reflected in record volumes, contract
value and profitability. Revenues increased two-and-a-half
times, reaching $101 billion. For the first time, Enron's pre-
tax net income exceeded $1 billion, a 32-percent increase over
last year, and shareholders received an 89-percent gain on the
stock price. Other significant highlights were included,''
which we won't go into that, but it will be down there.
Enron Business met with Jeff to discuss last year's results
and his outlook for 2001. Enron Business asked the question:
Enron had a great 2000. How did we do it? Jeff Skilling's
answered, ``Every one of our businesses performed beyond our
expectations.''
Well, you know, the way I look at that, is if there was any
truth in that, Enron would still be going strong. There was
something wrong somewhere along the line; in other words, the
inflated price or the process or the type or the manner of
bookkeeping or whatever might have been the problem.
But, you know, every time you talk to someone and you hear
someone else talk like on Committee and all, this must just be
one big dream, you know, because nobody did anything wrong. If
somebody didn't do anything wrong, why is Enron right now not
worth $100 a share? And it would probably go for, what, 10
cents, 15 cents a share?
That is my plea. As hard as we worked, in other words, it
was one of the greatest achievements in my life when I retired
knowing that I helped build the seventh largest corporation in
the United States. I was very proud of my company, you know,
and really I am still proud of Enron. Ninety-nine and one-half
percent of the people that worked for Enron are good people.
They are hard-working, tax-paying, vote-toting people, just
regular, common folks.
It is a shame that the little minority at the top of our
list or whatever it might be has destroyed such a great
corporation. To me, that is a shame. I thought we had some
protection on different agencies. Even at the Federal level, I
thought that we had some protection against things like that.
But I find out that I was wrong on it because the problems
that occurred with the bookkeeping or whatever the problem
might have been with Enron should have been taken care of in
1997, not 2001, because if it would have been taken care of in
1997, I firmly believe that Enron would still be going strong
today.
But, you know, there are so many ways that people can look
at it, but really and truly for us--and I feel like I am
speaking for all of the retirees, all of the ex-employees and
the employees that work for Enron now that lost everything they
had and lost their 401(k)s and their ESOPs, and also the ones
that got laid off and didn't get the right severance pay and
one thing and another like that. In other words, this is not
the American way. To put it real blunt and plain, this is not
the American way for things like that to happen and for people
to let things like this happen.
So I would like just to take a look at what down the road
looks like for me. Down the road looks real grim, real slim,
you know, but I hope and pray that things get better. I hope
and pray that my health holds up. If my health would hold up
and I was a young person, I promise you it wouldn't be any
problem. I would be out working somewhere. But I can't. I have
a heart condition and stuff, you know, so I am kind of at the
mercy of the world, so to speak.
I really appreciate you all listening to me and I am
honored to be here.
Chairman Biden. Mr. Prestwood, what do they call you,
Charles, Chuck, Charlie?
Mr. Prestwood. Charlie.
Chairman Biden. Charlie, when you were a young man, did you
ever think the day would come that you would know what a 401(k)
was or any of that kind of stuff?
Mr. Prestwood. No, sir, I sure didn't.
Chairman Biden. Did you feel pretty good about knowing that
stuff when you got to know it?
Mr. Prestwood. Yes, sir, I did, and for several years, my
latter years with Enron, I didn't save any money. But I was
always raised to save what you got, don't spend it, don't draw
your money out and buy that new car and get one like your
neighbor has or something. Keep it there, let it grow, you
know. What little bit you can save, put it in there and forget
it.
Chairman Biden. Charlie, when you were a kid, what made you
more angry, the guy who--what would upset you more, the guy who
came up to you and you knew wasn't your friend and tried to
take you on or the guy who you thought was your friend and you
found out when the fight started he was on the other side? Who
are you more angry with?
Mr. Prestwood. The second guy.
Chairman Biden. That is right.
Mr. Prestwood. The one that I thought was my friend.
Chairman Biden. Because he took advantage of you, didn't
he?
Mr. Prestwood. Yes, sir.
Chairman Biden. I think there are a thousand old
expressions that I think every legislator should understand
here because they know it in their heart, too. I am going to
make an analogy for you, something I spent a lot of my life
working on, and that is how women are victimized by violence.
I had a whole bunch of psychiatrists come and testify over
the years here, because men say sometimes, well, why, if a
woman is raped, doesn't she report it, or why can't she recover
from it or whatever. All these experts came, whether they were
liberal, conservative, whatever they were, and they said one
thing. They said, you know, a woman who is taken advantage of
walking down the street and somebody jumps out of a blind alley
and drags her in and abuses her, she is scarred and that is
real bad, but she can recover psychologically, mentally, with a
little help.
But the woman who gets in a car with somebody she has known
for 20 years, with somebody she works with, with the husband of
her friend or a guy that she voluntarily agreed to go out on a
date with, and he does something really bad to her, it takes
her a lot longer to recover because she ends up blaming
herself. She says ``why didn't I know?'' At least this is what
all the psychiatrists tell me, all the experts tell me.
Charlie, I grew up with guys like you, which I am proud of,
guys who busted their neck and thought just kind of fair play,
just fair play. If you wanted to get the guys in Claymont,
Delaware, which is a little steel town--if you wanted to get
them up, you just take advantage of them, suck them in, get
them to trust you and then violate that trust. Well, baby, then
you had a problem because that is the ultimate sin where you
and I come from, the ultimate sin, is to lie to me, pretend you
are my friend, lie to me and take advantage of me.
Mr. Prestwood. Right.
Chairman Biden. What happens is when it is all over, I
blame myself. Why didn't I know better? Why did I do this? You
lay in bed now wondering why you didn't take that money out of
that account now, right? I mean, now you wish you had taken
that money out five years ago, whether you bought that car or
not or done something with it, bought some land, right?
Mr. Prestwood. Well, yes, sir, but I don't know. I am from
the old school and I still trust people. The reason I didn't
take mine out is honesty. The reason I didn't is I trusted
Enron.
Chairman Biden. That is right.
Mr. Prestwood. I had full confidence in them, and then I
also trusted the Wall Street people. In other words, I looked
at that little computer everyday and when that Enron shop was
100 feet underwater, the analysts were still hollering,
screaming, ``strong buy,'' you know, and it is 100 feet
underwater. You know, that tells me something now.
Chairman Biden. That is where they belong, 100 feet
underwater.
I just think it is important that we understand this. This
is not a minor thing. Have you ever been robbed? I don't think
anybody your size, anybody would try to fool with you when you
were younger, but have you ever been robbed or your car stolen
or your house broken into?
Mr. Prestwood. No, sir. I have been fortunate, very
fortunate. Thank God for that.
Chairman Biden. Well, when that happens to you, unless you
are wandering someplace you think you shouldn't have been, you
usually go home mad. You don't go home wondering ``why did I
let that happen'' usually. Or if you come home and your house
is burglarized, it is like you are mad.
But when you say, hey, man, I will give you a ride, I will
help you out, and then he takes your car, that is a real
problem, right?
Mr. Prestwood. Yes, sir.
Chairman Biden. I will come back to you if I can, Charlie.
[The prepared statement of Mr. Prestwood appears as a
submission for the record.]
Chairman Biden. Ms. Farmer, I would like to hear what you
have to say, if I could. Thank you for, as Strom Thurmond says,
pulling that machine up close.
STATEMENT OF JANICE FARMER, ORLANDO, FLORIDA, ACCOMPANIED BY
JEFFREY FARMER
Ms. Farmer. I learn fast.
Chairman Biden. I can tell.
Ms. Farmer. I do appreciate the opportunity to be here
before this Committee, and I am a very proud woman and it is
with extreme emotional difficulty that I come here today to
share my financial plight and my personal problems. But I feel
compelled to explain my situation to you, and in doing so I
truly hope to be the voice of all Enron employees.
I once had $700,000 in my 401(k) savings plan, and that was
in late 2000. After years of hard work and dedication, I had
achieved my life's dream, enough money to retire comfortably
and live independently and financially secure. It was part of
my dream to leave my children and grandchildren a respectable
inheritance to enrich their lives.
For all of those years, I faithfully put money into my
savings plan and I fiercely protected it, never touching my
savings no matter what hardship came along. In 1994, Enron had
discontinued their formal retirement program and they made each
employee responsible for their own retirement planning. I still
tenaciously hung on to my dream and worked toward it.
Then, in 2001, at the most critical time, Enron denied
employees access to our own money. The shrewdly scheduled lock-
down of the 401(k) denied other employees and myself access to
our money for weeks, and this was just prior to the collapse of
the seventh largest corporation in the United States.
While company executives managed to sell stock worth
millions, we employees were brutally forced to watch helplessly
while the 401(k) lost $1.3 billion in value. As I understand
it, the plan administrators had the opportunity to either lift
or even postpone this lock-down and they chose not to.
I feel it is very clear that employees were not only
victimized by Enron executives, we were sacrificed for their
own personal gain, and what had taken me a lifetime to build
was destroyed in only a matter of days. When the lock-down
finally lifted and I was allowed access to sell my stock, I
received a check for $20,418, and that is all that was left.
I am now 61 years old. I won't have the opportunity to
recoup my losses. I suffer from degenerative arthritis of the
spine, along with three ruptured discs. I am diabetic, and that
has caused neuropathy of the lower extremities. I also have
Plantar's fascitis, which is like having constant muscle cramps
on the soles of both feet, and it is really painful and it is
disabling.
I try to get by now on Social Security survivor's benefits,
which is only about $500 a month, and that is after health
insurance and medical prescription costs. But out of that $500,
I also have to pay my car and house insurance and my property
taxes. Whatever will I do if I ever get sick or if anything
breaks down? I don't know.
I am afraid of my electric bill now. At night, I sit home
in the dark. I use no heat during the winter time and I don't
allow myself to use air conditioning. The lowest I have been
able to get my bill down to is $51. There are a lot of other
ways I save now. I stopped the newspaper delivery, and I was
really glad when I got a $33 refund on that because that is now
a week's worth of groceries.
I stopped by yard service and I try to do it myself on good
days. I cut my telephone and other household services to the
very minimum, and I don't shop at Publix anymore or nice
department stores. I shop at discount food stores and thrift
shops.
I don't mean to give the impression that I am too good for
this or above any of it, but this is not what retirement was
supposed to be like and it is certainly not what Enron had
touted to its employees all those years. We were lied to about
the financial condition of our company and the future of our
company. They told us everything was great, never better, but
those lies were all part of the sham and Enron had become a
house of cards, and the people that knew it protected only
themselves.
They took more than my money and my dream. They destroyed
my pride in my whole career. I am totally ashamed that I worked
for Enron. The emotional toll on myself and my family defies
description. The strength and the support from my children and
my close friends has been invaluable.
The executives, even this long after their criminal
behavior, go scot-free. They are living their normal lives of
luxury. They in no way have negatively been affected by their
illegal actions, and the amount of money they took from me
surely was 1 percent or less of what they already had and they
took my money anyway.
To me, what a blatant and enormous testimony to corporate
greed. When does it stop? If this is the way corporate America
repays dedication and loyalty, how many millions do they need
to feel secure? We employees, average Americans, trusted in the
system. We played by the rules, and we were lied to and cheated
not only by Enron but also the auditors and the Wall Street
analysts.
We have done nothing wrong, but yet we suffer the greatest
pain and we suffer the greatest losses. If the collapse of
Enron does not show that employees' needs and lives are being
swept under the carpet as mere inconveniences, what will it
take?
It is my deepest hope and prayer that this Judiciary
Committee can give us assistance in getting back what is
rightfully ours. Give us retribution, make us whole again, give
us protection, put into place measures that will help prevent
such rampant white collar crime, make the punishment more
appropriately severe and swift.
I truly appreciate the opportunity to participate in this
victim impact panel and to make my plea to you for justice.
Thank you.
Chairman Biden. Thank you, Ms. Farmer, for a very moving
statement.
Did you have a statement to make? You are welcome to if you
would like.
Mr. Farmer. Sir, I did not prepare anything for the
Committee. I am solely here for moral support, although I would
like to add that this morning while we three were sitting at
breakfast, and listening to Mr. Prestwood, I had a one-way view
of the situation that retirees were in from Enron, namely from
my mother's situation. But listening to Mr. Prestwood and as we
talked, I realized how many thousands more people it had
affected just from the Enron employees, their families, the
children of their families, everybody down the row.
I understand that it is my responsibility as a son to take
care of my mother. The burden falls on my shoulders and my
sister's shoulders as she gets on in years and needs our help.
It would have been a whole lot easier if Enron had taken care
of their employees like they should have.
I think at this point, although I am willing to accept the
complete responsibility of that, I think Enron or anyone in
this situation, any company that would do this to their
employees, should help with the responsibility.
Chairman Biden. There is an old expression: you can lock
your front door to keep the burglar out, but you can't lock
your heart to keep the liar out.
Ms. Farmer, your son and your daughter are prepared to take
care of you. Does that bother you?
Ms. Farmer. Yes, sir, it does.
Chairman Biden. Why does it bother you?
Ms. Farmer. Because I have always been independent. I have
been a single woman since the mid-1970s and I have always taken
care of myself and it has always been of utmost importance that
I maintain that capability to be their support. Now, like
Charles said, it has turned 180 degrees. I am now dependent on
them. They come down for Christmas dinner and they bring food.
It is not supposed to be like that. Everything I have worked
for all my life is gone.
Chairman Biden. I think that is an important point to make
here. My dad has been a hard-working guy his whole life. He is
87 years old and never worked for a company where they had a
pension plan, and the one that did lost it before we had
protection for pension plans. I am not alleging fraud or
anything. The company just went under.
My dad and mom have their house, and a long time ago I
authored a bill called the reverse mortgage which allows an
elderly person to be able to get a mortgage and get ``x''
number of dollars a month to help them sustain themselves, to
live in their house as long as they are alive, and when they
pass away the house is sold and whatever money that was gotten
to help them live is taken out of the proceeds of the house.
My mom and dad have four kids. My brothers and my sister,
like me, have been very successful. So my mom and dad are in a
position where they have sort of reinsurance from their
children. My dad is in pretty tough shape now physically and
they are living with me, but they still have their home because
we are going through this fiction that they are going to move
back into their home.
My mom came to me very upset that ``this reverse mortgage,
honey, is using too much of the value of my house.'' And I
said, ``Mom, it is okay, so what?'' She said, ``I will have
nothing to leave you, I will have nothing to leave you.'' My
mother is 85 years old and my mother doesn't want to take $500
a month out of her house to supplement her Social Security
because she is not going to have anything to leave me. I hope
when we think about penalties, we think about consequences to
people.
Now, my mom's situation is different. It is the same
impact, the pride piece, but I am not suggesting any wrongdoing
relative to anything that happened to my mother or father. But
I think sometimes we forget you raised us to be proud.
Ms. Farmer. That is right.
Chairman Biden. You raised us to be independent. I am not
very far behind you, by the way, in age, so it is not like we
are different generation here.
[The prepared statement of Ms. Farmer appears as a
submission for the record.]
Chairman Biden. Mr. Deputy, tell me about the deal down at
Metachem. How did you lose some of your retirement? How did
that happen? You are a pretty young guy. How old are you?
STATEMENT OF HOWARD DEPUTY, SMYRNA, DELAWARE
Mr. Deputy. I am 35.
Chairman Biden. Thirty-five years old?
Mr. Deputy. Yes, sir.
Chairman Biden. My staff tells me you lost a chunk of your
retirement.
Mr. Deputy. Yes.
Chairman Biden. How did that happen?
Mr. Deputy. They filed for taxes, like a tax extension, and
they said by law they could and then they closed the plant.
Chairman Biden. What were they supposed to do?
By the way, I understand you just got off work at six
o'clock and you hopped on a train?
Mr. Deputy. Yes, sir.
Chairman Biden. I hopped on the early train, too, but I
didn't work until six o'clock this morning. So obviously you
feel pretty strongly if you are down here and you worked all
night and you are on the train at seven o'clock in the morning
to get down here.
Let me make sure I understand. How does your retirement
system work at Metachem?
Mr. Deputy. Once a year, they would make their deposit when
they did your tax.
Chairman Biden. So when they did their taxes, what they
would do is the money you kicked in and the money that they had
promised they were going to put into this pension fund--right?
Mr. Deputy. Yes, sir.
Chairman Biden. They would put it in at the time that they
paid their taxes, right?
Mr. Deputy. Yes, sir.
Chairman Biden. Now, am I correct that Metachem made a
yearly payment, supposedly, of 6 percent of your annual salary
into an investment plan of your choosing?
Mr. Deputy. Yes.
Chairman Biden. So if your salary was $1,000, they paid 6
percent into a fund and they paid $60 into a fund?
Mr. Deputy. Yes, sir.
Chairman Biden. This year, how much were they supposed to
pay for you, do you know, into this fund when they paid their
taxes?
Mr. Deputy. It is roughly like $3,000.
Chairman Biden. Three thousand bucks, and that was for you
and all the other employees, right?
Mr. Deputy. Yes, sir.
Chairman Biden. What did they tell you? Did they put the
money in?
Mr. Deputy. For the first four months of this year.
Chairman Biden. So for 16 months, they didn't put any money
in, is that right? For 16 months they didn't put any money in?
Mr. Deputy. No, sir.
Chairman Biden. Did you know they weren't putting the money
into the fund?
Mr. Deputy. They gave us a letter right at tax time and
that is when they told us.
Chairman Biden. And what did they tell you?
Mr. Deputy. It was legal, you know. That is about it.
Chairman Biden. And so if I have it straight now, you were
supposed to have $3,000 deposited in your retirement account,
the investment plan that you had chosen, right?
Mr. Deputy. Yes.
Chairman Biden. And it was supposed to take place when they
paid the taxes. Tax time comes and they didn't put it in,
right?
Mr. Deputy. They filed for an extension.
Chairman Biden. They filed for an extension?
Mr. Deputy. Right.
Chairman Biden. And then what did they do?
Mr. Deputy. Then they filed for bankruptcy.
Chairman Biden. So, obviously, you are kind of in the back
of the line, then, now, right?
Mr. Deputy. Yes, sir. They took everybody's vacation, too,
that you had earned from the previous year.
Chairman Biden. Now, it is my understanding that this once-
a-year payment was made around the 15th of April of each year
for the prior calendar year. For example, in 2001 Metachem made
its employee contribution for calendar year 2000, and that is
how it worked until this year.
This year, Metachem didn't make an annual pension payment
for calendar 2001. I understand that the 2001 payment for union
employees was about $140,000 they were supposed to pay in for
union employees, right?
Mr. Deputy. Yes, sir.
Chairman Biden. For both union and non-union employees, it
was about $300,000 they were supposed to pay in, right?
Mr. Deputy. Yes, sir.
Chairman Biden. And they didn't pay any of that in?
Mr. Deputy. No, sir.
Chairman Biden. I understand that the specific 2001 pension
payment which Metachem was supposed to make into your account
was, they tell me, $2,688. Is that right?
Mr. Deputy. Yes, sir.
Chairman Biden. Now, I am not aware of any evidence of
fraud on Metachem's part, but I want to be clear about that. Is
it correct, Mr. Deputy, that you and the other employees
thought--what did you think about the timing of this? Let me
ask you that way.
Mr. Deputy. It was fishy.
Chairman Biden. It was fishy. Specifically, the company
told you that it could not make its annual payment because it
needed a tax extension, right?
Mr. Deputy. Yes, sir.
Chairman Biden. They didn't tell you they didn't make it
because they were fixing to declare bankruptcy, did they?
Mr. Deputy. No, sir.
Chairman Biden. Did you and the other employees believe, at
least at the time, that Metachem refused to make the annual
payment because they knew they were going bankrupt?
Mr. Deputy. No, sir, because we thought we were owned by
Charter Oaks.
Chairman Biden. Now, I don't have, again, any evidence of
wrongdoing on the part of Metachem in terms of criminal
wrongdoing, but I want to ask you a question about penalties
for other companies who defraud pensions. I want to ask all of
you this.
Pensions are regulated by a Federal statute known as ERISA,
the Employee Retirement Income Security Act. If a criminal
violation occurs under ERISA, however, the most the pension
crook can get is one year in jail. That is the most they can
get, one year in jail, regardless of how much money is lost by
the company's employees. Incredibly, it is possible that this
white collar crime crook could even get probation if your life
savings are gone forever. Now, that is under ERISA.
Were you aware of that, that you could only get one year in
jail?
Mr. Prestwood. No, sir.
Ms. Farmer. No, sir.
Chairman Biden. And that the defendant could actually get
probation if they were convicted?
Ms. Farmer. No.
Chairman Biden. Let me ask you this: What do you think is
fair? I mean, let's assume it was proven in a court of criminal
law that you were defrauded. What kind of penalty do you think
the people responsible for defrauding you should get?
Charlie, what do you think?
Mr. Prestwood. Mr. Chairman, would you let me answer that
in my point of view?
Chairman Biden. I sure would.
Mr. Prestwood. Lifetime, with no parole. There wouldn't be
too many people defrauding people then, you know. You set two
or three examples and the rest of them will take note of it, is
my way of thinking.
Chairman Biden. What do you think, Ms. Farmer, for real? I
mean, how do you think it should be dealt with? I know your
instinct and your heart would say hang them from the nearest
tree kind of thing, I guess, but if one year is not enough, how
do you--let me give you an example.
If you steal a car, under Federal law, and you take it
across the State line, you get 10 years in jail. Auto theft is
a serious crime and it should be dealt with severely. So if,
under ERISA, someone was convicted for violating that law, they
get one year in jail. If they steal your car and take it into
Georgia, they are going to get up to 10 years.
Ms. Farmer. To me, that makes no sense. I mean, there is no
equilibrium there; it doesn't balance. I tell you one thing, if
they get more than one year in the penitentiary, that would be
fine, but I just want what is mine. I want it back. They don't
deserve to have it.
Chairman Biden. Mr. Deputy?
Mr. Deputy. I think it should be the same penalty as like
with a gun, you know, a stiff penalty.
Chairman Biden. There is not a lot of distinction to you if
someone comes in and sticks a gun in your face and takes $3,000
of your money?
Mr. Deputy. Yes. You can't do anything about it, and the
same way when they sneak it out, you can't do anything about
it.
Chairman Biden. Well, that is one of the things we have to
look at here. I am not trying to hype this, but I think it is
important to just look at the equities here.
Ms. Farmer. I agree.
Chairman Biden. If I take your car and I take it into New
Jersey, and I take your car into Georgia, and take yours into
Oklahoma--I don't know why I would do that, but only a Texan
would appreciate that.
Ms. Farmer. Especially if you saw my car.
Chairman Biden. And no matter what your car is like, by the
way. Your car can be a 20-year-old jalopy or a brand new
Mercedes and there is no difference in terms of if they cross
that State line. It is 10 years.
Well, I want to thank you for taking the time to be here. I
know it is not easy, but it is important that we put a human
face on what we are talking about here. We are not just talking
about dollars. We are not just talking about, in the abstract,
people's futures are changed. We are talking about not only
your money gone, but your pride is gone and your sense of what
you think your responsibility is to your children is gone.
Ms. Farmer. Yes, sir.
Chairman Biden. Charlie--you know, here is a guy who busted
his neck, worked hard his whole life and got things those
college boys get, right? I mean, seriously, think about it,
think about it. This is a big deal. It wasn't just the money,
was it?
Mr. Prestwood. No, sir.
Chairman Biden. It was the knowledge that you built this
and you were part of this deal. I mean, did you ever think you
would be on a computer looking at stock prices, for Lord's
sake, and quotes when you were a kid?
Mr. Prestwood. No, sir. The only stock I knew of was the
animals we had out in the barn.
[Laughter.]
Chairman Biden. That is right, exactly right. By the way,
you couldn't afford to keep those animals right now, based on
what you have, right?
Anyway, I promise you we are going to try to come up with
an equitable way in which to deal with this because this has to
be fair. I want to tell you I can think of not a whole lot,
other than your physical safety, that I think we should value
more than your financial security.
The good news for Howard is he is 33 years old and he has a
whole life ahead of him. He is going to get a kick in the teeth
from this, whether there is criminal activity or not, because
of the bankruptcy, but I think he is going to be wiser for it
and know what is going on.
And I don't think it is a good thing for you, by the way.
Every time something lousy happened in my life, people would
say it builds character. And I would say I have got enough
character, I don't need any more character. I am not suggesting
you need any either, but in the case of our other two
witnesses, although they are not that old, for physical reasons
and others, their options are limited.
Charlie and Janice, to be blunt with you, I am not sure
there is anything we are going to be able to do to get you back
your money. That is another question, but I do think that we
have to consider what you both said that if there were adequate
penalties, maybe these guys would have thought twice about what
they did or didn't do when they were making these judgments,
if, in fact, penalties are deterrents, and I think in this case
they may very well be.
So I thank you all. If you have any closing comment any one
of you would like to make, I am happy to have it. I know you
probably got up early and you probably want to get going, but I
say to both of you my staff is available. Why don't you all
come around, and because you came a long way, unless you
already have plans, we will arrange for you to eat in the
Senate dining room or get you something to eat here. I mean,
this has been a real sacrifice to come up just for an hour or
so, so we will take care of that. I am not saying the Senate
will. I will. I want to make it clear I am not spending the
taxpayers' money here. This is not the taxpayers' money, okay?
Ms. Farmer. Thank you.
Chairman Biden. So we will just make arrangements if you
all need any because I know it was an inconvenience.
Howard, I will see you at home, but if you need anything
while you are here, too, I invite you to come into this room
and my staff will be there if you need any assistance or would
like any, or would like us to arrange to make sure you get some
lunch here, if that is okay.
Ms. Farmer. Thank you. That is a generous offer.
Chairman Biden. Well, thank you very much for being here.
Yes, Charlie?
Mr. Prestwood. Mr. Chairman, you know, looking at that
little chart up there, you take that car that would cost about
$30,000 and the criminal offenses over here could reach up to
maybe $2.2 billion. There is a difference there. Something is
wrong with the law or something, it looks to me like.
Chairman Biden. Well, I think you are right, Charlie, and
we are going to try to fix that.
Ms. Farmer. I agree.
Mr. Prestwood. I thank you, sir. It is an honor to be here.
Chairman Biden. Thank you. It is an honor to have you here.
While our first panel is clearing out, I want to again thank
them for being here.
Our second panel is James B. Comey, who was recently
appointed the United States Attorney for the Southern District
of New York. He attended the College of William and Mary and
the University of Chicago Law School, and later clerked for
Federal District Judge John M. Walker, Jr., in Manhattan.
As Assistant U.S. Attorney in the office he now heads, he
prosecuted members of the Gambino crime family. Before being
appointed to his current position, he served as Assistant U.S.
Attorney in Richmond, Virginia, where he earned praise as a
prosecutor. As head of an office that handles an enormous
amount of white collar crime work, we look forward to his
testimony today.
Glen B. Gainer, III, serves as the West Virginia State
Auditor and Chairman of the National White Collar Crime Center.
He is a trustee for the National Coalition for the Prevention
of Economic Crime, and chairs the Audit Committee of the West
Virginia Investment Management Board. He is on the Executive
Committee of the National Association of State Comptrollers and
is Vice President of the West Virginia Consolidated Public
Retirement Board.
Mr. Gainer, welcome to Washington.
Mr. Bradley W. Skolnik is the Securities Commissioner for
the State of Indiana and Chairman of the Enforcement Division
of the North American Securities Administrators Association, an
organization over which he presided from September of 1999 to
September of 2000.
Mr. Skolnik earned his bachelor's degree at Michigan State
University in East Lansing and his law degree at the Indiana
University School of Law in Bloomington. He began his legal
career as a law clerk in the office of a prosecuting attorney
in Michigan and went on to clerk for the Indiana Court of
Appeals. We look forward to his testimony, as well.
Frank O. Bowman, III, is an Associate Professor of Law at
Indiana University School of Law in Indianapolis, where he
teaches evidence, criminal law, and criminal procedure.
Following his graduation from Harvard Law School in 1979,
Professor Bowman entered the U.S. Department of Justice as part
of the Honors Graduate Program. He spent three years as a trial
attorney in the Criminal Division in Washington.
From 1983 to 1986, he was deputy district attorney in
Denver, Colorado, and he also spent three years in private
practice in Colorado. In 1989, Professor Bowman joined the U.S.
Attorney's Office in the Southern District of Florida, where he
was deputy chief of the Southern District Criminal Division,
specializing in complex white collar crime.
In 1995 and 1996, he served as special counsel to the
United States Sentencing Commission, in Washington, D.C., and
in 1998 to 2001 he served as academic adviser to the Criminal
Law Committee of the United States Judicial Conference.
Welcome, Professor.
Paul Rosenzweig is a Senior Legal Research Fellow at the
Heritage Foundation's Center for Legal and Judicial Studies. He
attended Haverford College, in Pennsylvania, a great school,
and the University of Chicago Law School, after he which he
clerked for the Eleventh Circuit Court of Appeals. He worked
for seven years as part of the Justice Department's
Environmental Crimes Section, and then for a time as the Chief
Investigative Counsel for the House Committee on Transportation
and Infrastructure. Most recently, he was senior litigation
counsel and associate independent counsel under Ken Starr. We
look forward to his presentation today, as well.
I thank you all for being here. If we could, if you would
begin and try to keep your statements relatively short, your
entire statements will be placed in the record.
If we begin in the order that I introduced you, Mr. Comey.
STATEMENT OF HON. JAMES B. COMEY, JR., UNITED STATES ATTORNEY,
SOUTHERN DISTRICT OF NEW YORK, NEW YORK, NEW YORK
Mr. Comey. Thank you, Mr. Chairman. Thank you for inviting
me here today. I welcome the opportunity to appear before this
Subcommittee on behalf of the Department of Justice to discuss
these important issues and the penalties for white collar
crime.
As you have said, Mr. Chairman, the swift and certain
punishment of financial crimes is essential to protecting this
country's economy. The prosperity of our great country and all
the good that flows from it are made possible by the Federal,
State and local laws that bring a degree of order and
predictability to commerce and that protect citizens from the
predation of criminals who use a pen or a computer and not just
a knife or a gun.
But as you also know, the real and immediate prospect of
significant periods of incarceration is necessary to give force
to those laws. Nothing erodes the deterrent power of our laws
and breeds contempt, frankly, for obeying the law more quickly
than if certain criminals appear to receive punishment not
according to the gravity of their offense but according to
their social or economic status.
The Department of Justice is committed to the vigorous
enforcement of laws against all forms of financial crime, and
our position on this issue is straightforward and we hope
inarguable.
White collar criminals have broken serious laws. They have
done grave harm to real people like the real folks who were
seated at this table before we sat down, and they should be
subject to the same type of retribution that we accord all
serious crimes--a significant chunk of jail time.
We have made significant progress in recent years,
especially in improving the Federal Sentencing Guidelines. We
are very pleased that the Sentencing Commission amended the
Guidelines for white collar offenses to raise the penalties on
those who are responsible for significant financial loss,
although the penalties were decreased to some extent for the
smaller-time crooks.
Both the Department and the Commission will be closely
examining the effects of those recent amendments on cases that
are just now being prosecuted and coming through our offices,
and we will pay particular attention to what happens at the
lower-end cases which make up a large proportion of the cases
prosecuted by U.S. Attorneys.
We remain concerned with amendment proposals that have been
made to the Commission in past years that could undermine the
progress that has been made so far. We are pleased that the
Commission has seen fit to reject efforts to reduce punishment
for the most serious offenders.
White collar offenders are generally better educated, in
the experience of U.S. Attorneys, and more sophisticated than
most criminals. They commit their crimes not in a fit of
passion or out of addiction or a craving, but with cold and
careful calculation. They are, in my experience, the most
rational of offenders and are more likely to weigh the risks
against the anticipated rewards of committing a crime.
They can be deterred, but the penalties must be certain and
significant. They have to fear going to jail. If you ask a
criminal defense attorney who represents a white collar
defendant, they will tell you the thing they are most afraid of
is going to jail. People like that with a lot to lose are
exquisitely sensitive to the pain of deterrence because they
don't want to go to jail.
The certainty of these significant penalties in white
collar cases also fosters trust in our criminal justice system,
which is the bedrock of the system. If drug defendants and
violent offenders are routinely sent away for long stretches,
while white collar offenders routinely get probation or home
confinement or a halfway house, people are going to start to
think that felons with wealth or privilege or education or the
right color are not held to the same standards as ``regular
criminals'' and that people are above the law. We believe that
white collar sentences to jail can and will lead to restitution
to the victims of their crimes. There is nothing inconsistent
about a jail term and restitution.
Lastly, I just want to add a word about downward
departures. Because Congress intended the Sentencing Guidelines
to cover nearly every factual circumstance in a criminal case,
judges are only rarely supposed to depart from the sentence
range that the Commission has set out.
We U.S. Attorneys are very concerned about the increasing
number of non-substantial assistance departures in white collar
cases, in particular. It sometimes appears that Federal judges
don't want to put white collar defendants in jail, and that
they work to eliminate or reduce that jail time because of the
defendant's civic work or charitable work or his great
employment record or his big family or his health problems, or
a whole host of factors that the Guidelines say are
discouraged, but that judges find are present to a degree
outside the heartland, and therefore it justifies sending this
guy home or to community confinement. These departures can be
found by a good defense lawyer in almost every case, and we
think they erode the already less onerous penalties in the
white collar area.
In conclusion, we think that white collar offenses are
situations where punishment and severity are vitally important,
as important as in the cases you mentioned, the drug and
violent crime cases. We appreciate the work of the Sentencing
Commission in bolstering the offense punishment for major
offenders. We hope that the Commission will continue to stand
strong against proposed changes that would undermine that
progress, and we look forward to working with the Commission
and this Subcommittee to ensure that Federal sentencing is
designed to reduce crime in the most efficient possible way.
That concludes my prepared remarks, Mr. Chairman. I ask
that the full text of my remarks be incorporated into the
record.
Chairman Biden. Without objection, they will be.
[The prepared statement of Mr. Comey appears as a
submission for the record.]
Chairman Biden. Mr. Gainer?
STATEMENT OF GLEN B. GAINER, III, WEST VIRGINIA STATE AUDITOR,
AND CHAIRMAN, NATIONAL WHITE COLLAR CRIME CENTER, MORGANTOWN,
WEST VIRGINIA
Mr. Gainer. Chairman Biden, I come to you wearing two hats
today, first as the State Auditor of the State of West Virginia
and its Commissioner of Securities, but also as the Chairman of
the Board of Directors of the National White Collar Crime
Center.
I am going to depart from my prepared remarks, since they
will be included in the record, and just speak briefly to a few
issues.
As a regulator of the securities industry and serving at
the National White Collar Crime Center, I see first-hand many
of the issues and problems that we are facing dealing with this
issue.
Too few resources. The National White Collar Crime Center,
as you probably are aware, is funded by the Congress through
the Department of Justice and Bureau of Justice Assistance. The
funding is greater than it has ever been in the past, but it is
still too few dollars to meet the great needs that we are
trying to achieve.
We have over 1,000 member agencies, representing attorneys
general, securities commissioners, State police, State and
local law enforcement, as well as prosecutors across this
country. We try to provide them support not only in financial
crimes training, prosecutors training, computer crimes
training, but we also try to provide them research and
analytical support.
Our research section has found through our last nationwide
study that most Americans view economic crime, or what we would
consider white collar crime, to be every bit as important and
deserve equal time and prosecution as traditional street crime,
though we know from our past history that is not the case.
We can look back to the 1990s when we had the savings and
loan scandal, where the average sentence for the folks involved
in that in excess of $100,000 received 36.4 months in jail. You
have already used the example of car theft. At that time, car
theft received 38 months in jail, traditional burglary received
55 months in jail, and drug offenders received over 64 months
in jail. As we can see, the sentencing is not equal.
Another area that we have identified, and I will say as a
securities regulator I find somewhat disheartening, is the
complexity of economic crime and the investigation required to
do that takes an expertise that is difficult to find. When you
do find that expertise, having the funds and the ability to
maintain that staff is difficult.
But even more disturbing is when you do put a case together
and you are successful in putting a case together, taking it to
the Federal prosecutors many times falls on deaf ears. I am not
criticizing the system. I understand the system. I understand
the burden and the crimes that they are trying to deal with.
Many times, white collar crime is looked at as a low priority.
From the standpoint of sentencing, why would a prosecutor
want to put in thousands of hours on a case, only to get a
conviction of perhaps parole or maybe a few months in jail? I
can understand their situation, but as a regulator I find it
difficult to deal with on a day-to-day basis.
I have to answer, as do you, to my constituencies in the
State of West Virginia. If we have Federal leadership in
strengthening the law, I believe that it will go a long way in
helping to prevent economic crime in this country. We must take
a strong stand.
Not only do economic criminals in this country need to
understand that they are going to be prosecuted, but there will
be severe penalties for that violation of the law. Many of them
right now in the environment that we exist in are willing to
take the gamble that if they are caught, they will not be
convicted, or if they are convicted, they will probably receive
probation or a very light prison sentence. This is truly an
issue that we must deal with and it has already been talked
about by the previous panel.
Thank you.
[The prepared statement of Mr. Gainer appears as a
submission for the record.]
Chairman Biden. Thank you.
Commissioner Skolnik?
STATEMENT OF BRADLEY W. SKOLNIK, INDIANA SECURITIES
COMMISSIONER, AND CHAIRMAN, ENFORCEMENT SECTION, NORTH AMERICAN
SECURITIES ADMINISTRATORS ASSOCIATION, INC., WASHINGTON, D.C.
Mr. Skolnik. Thank you very much, Mr. Chairman. I am Brad
Skolnik, Indiana's Securities Commissioner, and Chairman of the
Enforcement Section of the North American Securities
Administrators Association. I commend you for holding this
hearing today and thank you for the opportunity to appear.
Our country has undergone a historic transformation. In
just the past generation, we have become a nation of
shareholders. Today, half of all households are invested in the
stock market, and State securities regulators realize we have
an increased responsibility to make sure that Wall Street is a
safe street for Main Street investors.
Given all the news of late, which sometimes make the
business pages read like a police blotter, Congress,
regulators, and the industry must act to restore confidence in
the integrity of our markets, and we feel we can help do that
by holding those who defraud investors accountable for their
crimes.
The strongest deterrent to white collar crime, I believe,
as we have heard today, is criminal prosecution and prison
time, but there are significant hurdles we face. Prosecutors,
juries, and the media understand street crime like robbery,
assault, and murder. Somehow, securities fraud and other white
collar crimes seem sanitized, bloodless, and technical.
Many people, including some in law enforcement, view
securities fraud as an essentially victimless crime that
involves as much gullibility on the part of the victim as it
does culpability on the part of the perpetrator. But we know
white collar crimes aren't victimless crimes. Just like street
crime, securities fraud ruins lives, destroys families, steals
hopes, and kills dreams.
Oftentimes when faced with a problem, the temptation is to
propose new legislation. In my opinion, to protect investors we
need to make better use of the laws already on the books. This
means bringing more criminal actions against white collar
crooks.
One problem is that securities cases are complex, costly,
and time-consuming, and these are serious deterrents to law
enforcement agencies with limited personnel and budgets. The
prosecution of complex white collar criminal cases take time
and money, lots of money. It is critical that prosecutors and
law enforcement officials be provided with the resources
necessary to investigate and prosecute these cases.
The truth is some prosecutors shy away from them because
the subject is complicated and difficult to understand. A
prosecutor's willingness to undertake a complicated and
technical securities case also depends on other cases competing
for attention. Murders, other forms of violent crime, and drug-
related cases are sometimes easier to argue to a jury and don't
require the amount of staffing or special expertise often
required for criminal prosecution of a complex securities case.
But from my perspective as a State securities regulator, white
collar criminals who commit securities fraud deserve time just
like thieves, muggers, and murderers.
There are some ways my colleagues can help. State
securities regulators can and do provide resources to
prosecutors to assist with the investigation and prosecution of
these cases. We can develop cases fully and hand them over to
prosecutors, both Federal and State, reducing the burden on
them substantially.
Moreover, when criminal convictions are obtained in white
collar cases, the sentences imposed are often insufficiently
severe, considering the amount of harm inflicted. Think about
it. If someone steals your car, they go to prison. If some con
artist steals the money your parents need for retirement, they
get fined. That is just not right.
I also think it is important for us to stop using
euphemisms when we talk about white collar crime. White collar
criminals are cold, calculating, and vicious. All too many are
serial violators, career criminals. It is probably way past
time we called a crook a crook and put more of them in jail.
On the legislative front, State securities regulators
support S. 2010, the Corporate and Criminal Fraud
Accountability Act of 2000, and believe it sends a powerful
message that wrongdoers in the securities markets will be
punished.
Unfortunately, white collar crime is not as high on our
national agenda as it needs to be. However, the problems in
this area can be successfully addressed if law enforcement
officials, regulators, Congress, and others work together on
solutions. I am optimistic that the battle against white collar
crime is winnable, given the will and the right amount of
resources.
Again, I thank you for holding this hearing and would be
pleased to provide any additional information you may need.
[The prepared statement of Mr. Skolnik appears as a
submission for the record.]
Chairman Biden. Thank you, Commissioner.
Professor?
STATEMENT OF FRANK O. BOWMAN, III, ASSOCIATE PROFESSOR OF LAW,
INDIANA UNIVERSITY SCHOOL OF LAW, INDIANAPOLIS, INDIANA
Mr. Bowman. Chairman Biden, thank you very much for
inviting me to be with you here today. My name is Frank Bowman
and I am a professor at the Indiana University School of Law in
Indianapolis.
As you were kind enough to mention, before becoming a
teacher I practiced law for a good 17 years and served for
roughly 13 years as a prosecutor in State and Federal courts.
In 1995 and 1996, I was detailed by the Department of Justice
to serve as special counsel to the U.S. Sentencing Commission,
and during that detail I became involved in the Commission's
long project of rethinking and revising the Sentencing
Guidelines governing economic crimes, a project which finally
came to fruition in May of 2001, when the Commission passed its
so-called economic package of guidelines amendments.
When I left the Government to teach in 1996, I began to
write about sentencing, and in particular about the sentencing
of Federal economic crimes. I continued to work in the
political realm and in the policy realm on economic crime
sentencing reform.
During the five-year process of rewriting the Federal
economic crime sentencing guidelines, I had the honor to work
closely with all of the groups most interested in the reform:
former colleagues in the Justice Department, representatives of
the defense bar, the Criminal Law Committee of the U.S.
Judicial Conference, and of course the Sentencing Commission
itself. The lessons I learned during the last five years inform
much of what I have to say this morning.
The question for today is whether we are tough enough on
white collar crime. I want to make four points.
First, the average sentence imposed on a defendant
convicted of an economic crime, defined broadly, in Federal
court is certainly significantly lower than the average
sentence in any other major crime category. Economic crime
defendants, broadly defined, get probation far more than any
other sort of defendant. I have included in my written
testimony a chart which reflects the precise figures for fiscal
year 2000.
However, I want to emphasize that I think this comparison
of categories is probably misleading. Most Federal prosecutions
categorized as economic crimes are simple crimes that involve
relatively small sums of money. For example, in 1999 half of
the defendants sentenced for theft crimes and 22 percent of
those sentenced for fraud stole less than $10,000. That is not
a minor amount of money, but in the scheme of the kinds of
frauds that we have been discussing this morning, it is
relatively small.
Moreover, a big chunk of the Federal economic crime
caseload consists of thefts or misappropriations of Government
benefit checks, thefts of Government property, simple
embezzlements from federally-insured banks, and similar
matters.
Prosecution of these kinds of cases is certainly necessary
particularly where the Government itself, and thus the
taxpayer, become the victim. But there is, I think, little
evidence that crimes of this sort are under-punished.
Therefore, I think that sentencing averages for all Federal
economic crimes don't tell us very much about the
appropriateness of the punishments imposed on the kind of folks
that you, Senator, were presumably thinking about when you
scheduled this hearing--people I will call serious white collar
offenders, people who stole a whole lot of money in a
reasonably complicated way.
The second point I want to make is a historical one, and
that is across the board for both routine, small-fry types of
thieves and for serious white collar offenders, Federal
economic crime penalties are now markedly higher than they used
to be.
Prior to the enactment of the Federal Sentencing Guidelines
in 1987, probationary sentences were the norm in Federal
economic crime cases, often in serious white collar cases
involving significant financial losses. The original Sentencing
Commission consciously sought to change this. They wrote
guidelines that effectively mandated prison sentences, absent
departures at least, for all defendants who stole more than
roughly $120,000 or so.
In addition, by tying increases in sentence length to
increased amounts of loss, and by adding sentencing
enhancements for factors like abuse of trust, the guidelines
began routinely generating multi-year prison sentences for
white collar defendants who, before the guidelines, would have
escaped with probation or a term of mere months.
Chairman Biden. I might add that was one of the reasons why
I wrote the legislation. Everybody thinks it was only the
violent criminals, but we had a lot of hearings and that was
one of the big issues back then.
Mr. Bowman. Senator, although many people are not great
fans of the guidelines, I for one am, and I want to thank you
for your good work in helping----
Chairman Biden. Well, thank you. I didn't intervene for
that, but thank you.
Mr. Bowman. I want to go on to say that even though the
guidelines raised the historical level of white collar
offenses, in the years after the guidelines were adopted many
judges, probation officers, and prosecutors felt that sentences
for serious white collar offenders were still not high enough.
As a result, one element of the Sentencing Commission's
2001 economic crime package was an increase in sentences in
cases with larger loss amounts. So the effect of the guidelines
on white collar criminals has been to put more of them in
prison for longer, and the effect of the new 2001 economic
crime amendments to the guidelines will be, I think, to
increase white collar sentences still more, at least for high-
loss cases.
Therefore, another way of framing the question being asked
here this morning might be: we have gotten tougher on white
collar crime, yes, but have we gone far enough? Now, of course,
there is no objective or empirical way of deciding how much
punishment is enough.
For example, in my own view, comparisons to other
dissimilar types of crime may not be very helpful. People often
remark on the substantial difference between economic crime
sentences and drug sentences, but one has to ask whether the
lesson to be drawn from this comparison is that economic crime
sentences are too low or maybe that drug sentences are too
high, or maybe the differential is just right because they are
not comparable types of crimes.
I think about the best we can do is to make some
necessarily imprecise judgments about whether prevailing
punishment levels are likely to act as effective deterrents to
crime, while at the same time being neither undeservedly
lenient or undeservedly harsh.
In my written testimony, I have provided some examples of
the sentences that both the old and new guidelines would
produce for some hypothetical white collar criminals who steal
sums in the range of, say, $750,000 to $1 million or $2
million.
Depending on the particular circumstances in such cases,
other than loss amount, such defendants now would be sentenced
to prison anywhere from 2 \1/2\ to roughly 17 years. Lower loss
figures would produce slightly lower sentences. Higher losses
would produce higher ones.
As just an interesting aside perhaps, I did a quick
calculation during the testimony of the previous panel.
Assuming that facts were to arise giving rise to criminal
liability for people involved in the Enron scandal, which
produced losses presumably much in excess of $100 million, and
if such persons were to be brought to trial and convicted, they
would now receive sentences in excess of 20 years.
My third point, therefore, is this: Sentences at this level
may be a bit too low in some cases and a bit too high in
others, but I find it fairly hard to assert categorically that
sentences in this general range are obviously unreasonable.
Indeed, I suspect that in most cases, most people would
probably conclude that the sentences now prescribed by the
economic crime guidelines closely approximate rough justice.
At a minimum, I think that current economic crime sentences
are not so obviously low that Congress should command the
Sentencing Commission to enact a blanket increase applicable to
all economic crimes, or maybe even to all economic crimes above
a certain loss amount.
I would like to suggest further that Congress should be
especially cautious about pressing for any across-the-board
white collar sentencing increases less than a year after the
Commission, in conjunction with all of the interested parties,
including the Justice Department, passed its economic crime
amendments. The sentence increases in that package have really
basically not even come into effect yet and it will be some
years before we can determine what is really happening there.
There may be specific types of economic crime or specific
aggravating factors that the Commission has not properly
accounted for and which deserve additional sentencing
enhancements. In my written testimony, I note several such
factors mentioned in Senator Leahy's bill, S. 2010, and I am
particularly interested in the proposed enhancement which I
think may be particularly appropriate, given the testimony we
have heard today, for causing victim insolvency.
Fourth, and finally, the last point I would like to leave
you with is that toughness on crime, and economic crime in
particular, should not be measured solely by the length of the
sentences we impose on the white collar defendants whom we
catch and convict, but by the resources we devote to ensuring
that all those who commit serious white collar crime are caught
and are punished.
For reasons that have to some extent been laid out here
today and which I explore more in my written statement, in the
United States the Federal Government is the primary, and in
some jurisdictions virtually the sole investigative and
prosecutive authority for complex economic crime.
I would submit that the most valuable thing that this
Subcommittee and this Congress could do to fight white collar
crime in America would be to appropriate and dedicate
additional funds for the Justice Department and the regulatory
and investigative agencies who fight white collar crime.
[The prepared statement of Mr. Bowman appears as a
submission for the record.]
Chairman Biden. Thank you for a very thoughtful statement.
I appreciate it.
Mr. Rosenzweig?
STATEMENT OF PAUL ROSENZWEIG, SENIOR LEGAL RESEARCH FELLOW,
CENTER FOR LEGAL AND JUDICIAL STUDIES, THE HERITAGE FOUNDATION,
WASHINGTON, D.C.
Mr. Rosenzweig. Thank you, Mr. Chairman. As you have said,
my name is Paul Rosenzweig and I work at the Heritage
Foundation. I am also an adjunct professor at George Mason
University, where I teach white collar and corporate crime, so
this is a subject near and dear to my heart.
I also find myself quite comfortable as last on this panel
because that position will allow me to be brief. I find myself
in agreement with much of what has been said already. I concur
wholeheartedly that some of the problem is the lack of devotion
of resources appropriately to the prosecution of white collar
crime.
I agree, as well, that part of the problem is the intricacy
and difficulty of proving those crimes, and that is perhaps
something inherent in the nature of white collar crime that no
act of Congress or the Sentencing Guidelines and no devotion of
greater resources can or ever will solve.
When and if there is ever a trial of a fraud of the size
alleged potentially against Enron, that trial will occupy a
court and a dozen prosecutors for nigh on six months, and still
may be impenetrable to either the judge or the poor jury
obliged to sift its way through the intricacies of the finances
there.
I also agree with Professor Bowman that for the most part
the Sentencing Guidelines have moved substantially in the
direction of making more equivalent white collar and street-
type crimes.
The two points that I would add that are perhaps different
than those that have already been brought forth are these:
First, to some degree I think we need to absolve the courts of
responsibility for such disparities as remain. Much of the
cause of that lies not with them, but either here in Congress
or in the guidelines themselves.
In my written statement, I have provided you with some
information about the rates of imprisonment that are given to
defendants in situations where judges have discretion to choose
either imprisonment or some non-imprisonment type of
punishment--home detention, community service, probation, that
sort of thing.
If we look at that data, we see that in those situations
where discretion remains in the district court judges doing
sentencing, for the most part the rates at which they impose
imprisonment don't vary that much based upon the nature----
Chairman Biden. Is that your chart on page 6?
Mr. Rosenzweig. That would be the one on page 4 that I am
looking at, the rates of imprisonment.
We do see that drug traffickers get----
Chairman Biden. I guess I have a different pagination.
Mr. Rosenzweig. Okay, it may very well be. I submitted it
by electronic mail and the pagination may have changed.
Chairman Biden. Is it the first chart you have where it
says ``Crime Type,'' ``Rate of Imprisonment,'' ``Fraud,''
``Larceny,'' ``Immigration,'' et cetera?
Mr. Rosenzweig. Yes.
Chairman Biden. Okay.
Mr. Rosenzweig. But as you can see, that applies to only
some 11,000 individuals in fiscal year 2000, out of roughly
60,000 who were sentenced. So this is only one-sixth, more or
less, of the total number of people sentenced. For most
situations, either some congressional enactment, a mandatory
minimum sentence for a drug offense or some operational
guidelines, didn't afford the courts any discretionary
opportunity.
The other area in which we might expect or we might think
that we would see a bit of disparity would be in the rates of
departure. If the guidelines command sentencing, we might ask
whether judges are, for example, preferentially departing more
frequently in white collar cases than they are in street crime
cases. That would be the third chart I have, again ``Rate of
Departure,'' and there again there are some variations amongst
the various types.
But when I went and pulled this data down, I was actually
fairly comfortably surprised to find that the rate of departure
for robbery is not appreciably different from the rate of
departure for fraud.
Chairman Biden. For fraud, you have 9.2 percent; robbery,
12.7.
Mr. Rosenzweig. That is right, so in 12 percent of the
cases where the crime of conviction is robbery, nationwide
judges are departing from the guideline range.
Chairman Biden. Now, when you say ``depart,'' did you make
a distinction of departing up or down?
Mr. Rosenzweig. These are downward departures. There were
so few upward departures----
Chairman Biden. I just wanted to make sure I had the facts.
That is all.
Mr. Rosenzweig. The data I am reporting are for downward
departures, and I should add are exclusive of substantial
assistance departures, which are the predominate method by
which departures are found. A defendant provides substantial
assistance to the Government and then the Government moves with
for a departure from the guidelines. These are departures for
other reasons, ranging from extraordinary circumstances to----
Chairman Biden. I understand. I just wanted to make sure I
understood.
Mr. Rosenzweig. So, taken together, these two pieces of
data say to me, at least, that when judges are exercising some
form of discretion or choice, they are winding up not making
too much of a distinction in the way that they exercise and the
frequency with which they exercise discretion between white
collar offenses and street crime, blue collar offenses.
So that brings me back to the converse point, which is that
then the disparity in sentencing which remains that in the
chart above that, it is quite clear robbery sentences, drug
trafficking sentences are getting substantially longer mean and
median sentences than environmental sentences or antitrust
sentences.
Those must be the product of the operation of either
statutory maximums or potentially the way the guidelines
themselves are structured. I agree with Professor Bowman that
the amendments from 2001 which are designed to alter the way we
calculate loss may go some way toward changing that, and I
agree as well that it is too early to tell.
The point I would add to the testimony of Mr. Skolnik is I
agree that a large fraction of this is a lack of resources for
these difficult cases. I am not so sure that it is necessarily
that we are focusing exclusively on street crime. I think
sometimes we are also mis-focusing our efforts within the white
collar crime area.
Professor John Coffee has talked about the technicalization
of criminal offenses, and therefore criminalization in areas
which are more appropriately treated civilly. Plainly, the
situations that we are discussing here today, the allegations
against Enron, if proven, don't fit in that category. They are
classic common law frauds that are and ought to be punished
severely if indeed proven to be true. But part of it is that
within this complex area, we sometimes mis-focus the resources
in areas where we are not being as effective.
I would urge this Subcommittee, if it could do one thing,
to try and ask the Federal agencies responsible for criminal
law enforcement to make a better effort at assessing their
effectiveness, assessing whether or not their resources are
being used productively in areas where, in fact, we are going
to get the biggest bang for the buck.
To date, we don't try and measure that. We never try and
draw a line between enforcement and increased regulatory
compliance, for example. We count beans, we count numbers of
prosecutions. As I said in my written testimony, that would be
as if the Metropolitan Police Department counted murder
indictments without ever asking whether or not they are
actually lowering the murder rate. That is our goal, that is
everybody's goal, is to deter crime and lower the incidence of
white collar crime.
I thank you for the opportunity to testify.
[The prepared statement of Mr. Rosenzweig appears as a
submission for the record.]
Chairman Biden. Thank you very much. I think the last point
you make is a very good point. In fact, we do that all the
time. We have Texas talking about the number of death penalties
without ever examining whether or not they have impacted at all
on the murder rate, which they haven't. So it is always an
issue.
I would like to begin with you, Mr. Rosenzweig. I agree
with the bulk of what you had to say. I would like you to
expand on what you did not spend enough time on because of
trying to accommodate me, the distinction between--you touched
on it, but I would like you to be more graphic, if you would--
the distinction you make in your written statement between the
type of white collar offenses, the white collar offense that is
the one that basically is the Enron type, which, as you say,
could be referred to as a definition of fraud by another name,
and then the white collar offenses which you argue are quite
different that involve prosecution for violation of rules and
regulations that are part of a larger statutory structure.
Can you amplify on that a little bit?
Mr. Rosenzweig. Yes, I would be happy to. What I have in
mind is a trend that has grown increasingly in the criminal law
over roughly the last 50 years, in which we have seen basically
a diminution of criminal standards of intent for some
regulatory offenses and in increasing trend toward prosecuting
what I would perceive as technical violations, to the detriment
of looking at the more significant frauds.
Later in the testimony, I cited one example where some of
this is actually quite frequent in Medicare fraud. There are
plainly two types of Medicare fraud out there. There are
instances plainly in which HMOs and individual doctors are
deliberately lying about what services they are providing,
taking Federal money as a result. When caught, they deserve,
like any other thief, to be prosecuted in the same way.
Contrast that, however, with many doctors, some of whom are
leaving the profession because of this, who are genuinely
confused as to proper coding. There are literally 100,000 pages
of Medicare regulations. The average doctor gets 35 pounds of
them on his desk each year, in which he is supposed to code
correctly.
The key, to my mind, to distinguishing between those lies
in definitions of criminal intent. We have historically
punished people with specific intent to do a wrongful act
harshly, and they deserve such punishment. But, increasingly,
we have adopted rules of construction that presume for small
businessmen, doctors, knowledge of the regulatory environment.
And they, either through ignorance, mistake----
Chairman Biden. Negligence.
Mr. Rosenzweig.--fail to come up to snuff. It is a bad use
of our resources, first off, because the true frauds don't get
prosecuted. I think it also diminishes respect ultimately for
the criminal law because we look at people who don't have that
same degree of moral culpability and are deserving of
punishment. Dr. Vargo is not one of those people.
Chairman Biden. I appreciate the distinction. I think it is
worth keeping in mind.
I would like to ask all of you to respond now to the
various questions I am going to ask. Each of you need not
respond to every question, but you are welcome to if you like.
The professor just indicated that depending on which crimes
we pursue and how we pursue them and what offenses we pursue,
we either enhance or diminish respect for the law. I remember
as a law student reading Jerome Frank's Law and the Modern Mind
and this notion of a judicial myth and this idea that it
matters that people think that the system is fair. It matters
that people think that judges are totally objective. It matters
when things occur intentionally or unintentionally that lead
people to believe that neither exists, that it is neither fair
nor that the judge is objective.
I think that applies here because the thing that you hear
most often here stated, whether it is true or not--and I think
the testimony of our last two witnesses indicates that the
disparity, at least at the Federal level, is not nearly as
extreme as it is perceived by the average person. Having held
so many hearings over the years on criminal justice issues, how
many times have we discussed this issue of prosecutorial
discretion as it relates to plea bargaining?
What I would like to raise with you, particularly former
and present prosecutors--and I would start with you, sir--is
there any data that indicate that white collar prosecutions are
either pled down considerably, allegations of white collar
crime, either indictments or even failure to seek indictments
are treated with any less diligence than drug-related crimes or
crimes of violence or other economic crimes that the average
person thinks of as non-white collar crime--burglary, robbery,
et cetera.
Can anyone comment on that?
Mr. Comey. Senator, I don't know if a data set exists on
that, and I am sure we can check and get back to you, but it
ought not to happen. Under a longstanding Department of Justice
policy, the guidelines are supposed to be as restrictive for
the prosecutor as for the judge.
As I have told my people, if you don't like the guidelines,
that is too bad. They should channel your discretion because
you can't fact-bargain and you can't charge-bargain. The
Department of Justice policy since the so-called Thornburgh
memo in 1989, which is still in force, is that you must charge
the most serious readily provable offense and the plea must be
to that offense, and all relevant conduct that is provable must
be included in the sentence. So there shouldn't be any jacking
around on the prosecutor's end, which is not to say it doesn't
happen.
Chairman Biden. I understand. It is an important point.
Mr. Skolnik, you look like you wanted to respond.
Mr. Skolnik. I think the question is a very good one, Mr.
Chairman. A lot of the data we seem to cite tends to be
anecdotal and may or may not be accurate in looking at the big
picture.
It is my impression at the State level that there are
instances, and I can recall some from my own State, where
prosecutors have been reluctant to take cases because of the
significant burden that it would impose on them. When we are
talking about county prosecutors in many smaller communities,
their staffs are really not that large. Oftentimes, they even
rely upon part-time deputy prosecutors.
So I think from an anecdotal standpoint, it is my
perception that if a State securities commissioner brings a
county prosecutor a rather complex, resource-intensive
securities fraud case that you oftentimes will encounter some
level of concern by the prosecutor and they probably are going
to wish that you would take it someplace else, if not to the
Federal level, maybe to a larger county.
Chairman Biden. Professor Bowman, you have been a State
prosecutor and a Federal prosecutor and you know the Federal
system well. I am not sure if the last panel or this panel
indicated that, for good or for ill, sometimes we set a
standard here. We raise the Sentencing Guidelines and it puts
pressure on every State in the Nation to raise sentencing
guidelines because people come along and say, well, look, if
this were in Federal court, they would go to jail.
Sometimes, I have been responsible for that and it has had
a positive effect and sometimes it has not been as positive an
effect. I am sure it exists here, except the one place that I
wonder about is--and I am going to get to the resource question
in a minute and I would like you all to speak to that.
Since I have just begun this, I don't have enough data to
make the kind of case I would ordinarily make or to make a
judgment. My impression is that the allocation of resources at
the Federal level, even though they may be disproportionately
low to other allocations of resources in the criminal justice
system--and that is arguable and I want to get to that issue in
a moment--are considerably more than they are at the State
level in most States.
Am I on the right track, Frank? Is that your experience, or
do you have any evidence from your academic endeavors to
support that?
Mr. Bowman. I have no data, Senator, but I think your
observation is undoubtedly correct as a generality. As I
indicated in my written testimony, I was a deputy district
attorney in Denver for a number of years. In fact, I was for a
while the only person in the office who was specifically
dedicated to doing anything remotely related to white collar
crime.
The basic attitude of my office and of the police
department--and I am not criticizing this; it is just the
culture that prevails--was that paper crimes aren't real crime;
they are civil matters, regardless of the intent involved, and
so forth and so on.
Some of that is cultural, and it is understandable when you
are in an office where the bulk of your work is, and is
perceived to be, response to crimes like murder and rape and
robbery which have so much more emotional appeal. Part of that
response has to do with a lack of expertise. Very few local
prosecutors' offices have the expertise to engage in complex
white collar prosecution.
Part of that is limitations on tax dollars that flow to
them. Some of that probably is political in the sense that if
you are an elected district attorney, the mileage is in the
high-profile murder case and probably in some relatively
obscure group of financial crimes.
But for a lot of reasons, all of which I am sure you are
very familiar with in your many years of work on this area,
local prosecutors tend not to do this kind of work, and
therefore it becomes particularly incumbent, in my view, on the
Federal Government to take the lead because in most places and
most times we are the only game in town.
For most local prosecutors, if they come across a big case
and they really perceive that it has some criminal value, their
instant reflex is to call the U.S. Attorney's Office and say
this is your job, guys, you take it.
Chairman Biden. That is my experience. My son is a Federal
prosecutor, although he was on the criminal side in
Philadelphia, which is a gigantic office, as you know, Mr.
Comey. The gentleman sitting behind me was a Federal prosecutor
at the Justice Department for some extended period of time.
One of the things I would like to raise--and these are not
accusations. I want to make that clear because this is a
dangerous--I quite frankly wrestled with whether to have this
hearing, in light of Enron and a lot of other things, because I
want to be as sober about this as I possibly can, which I hope
I have been on other matters relating to the criminal justice
system. My impression is there is another factor.
I know, Professor, you may have wanted to comment on that
last point, and if you will hold the thought, I just want to
pursue this one piece.
One of the reasons why local law enforcement and local
prosecutors may not proceed and assume that it is the Federal
Government's job, and I raise this as a question--is in some
States and localities, proceeding against the county's largest
employer or proceeding against the county's most prominent
citizen who has donated everything from the playground to the
opera house, especially since it is an uncharted area and not
knowing how to proceed very well, is a place people tend to not
want to go, my instinct tells me.
I would like your opinions on that. Is there sort of a
limiting aspect to the instinct to proceed at a local level or
even at a State level? For example, I bring down frequently the
lead Medicare fraud folks we have at the Justice Department. We
have one of the best in Philadelphia, I mean really a first-
rate team, and we have one in California and the Southern
District. There are some that are particularly well-known and
you use around the country. I actually bring them down to do
seminars for local law enforcement and for senior communities
as to what to look for.
There is not a lot of reluctance to go after Dr. Smith, who
has billed falsely 3,000 mammograms or whatever. There is a
reluctance to go after the xyz hospital, which is sometimes the
biggest employer in a community, in a city, in a county. I
wonder whether or not that plays. How would you guys factor
this in?
The reason I bother to ask you this is I am not looking to
indict local officials in any way, but figure out the resource
allocation here. Should we be, for example, kind of like the
crime bill, which you probably don't like--the Heritage
Foundation, I mean--should we be out there saying to local law
enforcement and local prosecutors that at the Federal level, so
not everything bubbles up to us, we will have an amendment to
the crime bill--I am not suggesting one--to provide you ``x''
number of dollars to hire prosecutors to pursue white collar
crime?
Or should we be saying to Main Justice we want to enhance
your budget, so that we are going to increase the funding that
provides you the ability to hire ``x'' number more prosecutors,
investigators, accountants, and the various technical people
you need in order to be able to pursue white collar crime?
That is why I am asking these questions, so you don't think
it is just an exercise in futility here, to try to get the best
sense of which way, if at all--and maybe we shouldn't be doing
anything more; that is, we who sit up here in the Congress, in
terms of either changing the penalties, changing the
guidelines, changing the allocation of resources. So that is
why I ask the question. Sorry for the long prelude.
So can you comment for me instinctively on what you think,
based on your experience? We will start with you, Frank, and
then I know, Professor, you had something you wanted to say,
and anyone else who wants to respond. If you have no response,
that is okay, too.
Mr. Bowman. Two quick observations. One, I think your
instinct that, again, as a broad generalization and supported
by no data and only my own personal experience--one way or
another, I have been either an actual, full-time or special
assistant U.S. Attorney in three different districts around the
country, and I have been a deputy D.A. in Denver, and so forth
and so on.
Based on my limited personal experience, I think your
perception that local officials sometimes feel constrained to
bring white collar and other types of cases, including, for
example, public corruption, feel more constrained than perhaps
their Federal counterparts might--I think that is, as a
generalization, probably not at all unfair.
I think that Federal prosecutors sometimes see themselves--
I certainly did--as sort of the force of last resort to deal
with sometimes locally intractable problems. So I think that
your instinct is certainly consistent with my experience,
though I can't prove that that is true.
The second part of your question I take to be sort of from
a resource perspective what would be the best thing to do if we
had the money and the will to do it. My own sense is that
certainly at the Federal level, the Federal effort would
benefit from an increased allocation of resources.
There is always, of course, the problem with which you are
certainly more familiar than I of making sure that money that
is appropriated in Congress is spent for the purpose for which
you wish it spent. But I think there are some models
historically with respect to the Department of Justice in the
white collar area to which you might look--the additional sums
that were allocated in the wake of the savings and loan
scandal, the additional sums that were allocated to beef up the
health care fraud initiatives in the Department.
I am not familiar with the specifics of the legislation,
but my understanding is that certain restrictions were placed
on how the Department allocated those funds.
Chairman Biden. They were.
Mr. Bowman. That is obviously a model to which one could
look, although in this particular case what we are talking
about, it seems to me, is a somewhat broader question, white
collar crime more generally, and how you would craft that
legislation to get the money to the place you want it to go is
beyond my competence.
Chairman Biden. That has never slowed up any Senator.
Mr. Bowman. The last suggestion you make is an interesting
one which I had never thought of before, the notion of some
sort of funding passing through the Department or some other
entity to States.
Chairman Biden. We have done it clearly on the violent
crime side of the equation. We have done it clearly in other
areas, so it is not unique.
Mr. Bowman. It sounds like a tremendously intriguing idea,
and thinking completely off the top of my head and
spontaneously the only impediments perhaps that one might see
are, at least in the violent crime area if you are giving local
prosecutors more money, you are giving them more money to do
something they already know how to do.
Chairman Biden. Correct.
Mr. Bowman. They know how to do it and they know how to
train people to do it. If you give them more money to do
something they don't know how to do, they may be a little bit
more reluctant.
I also think that perhaps it may be difficult to give them
sufficient funding to train and keep the kinds of people with
the kinds of skills that you need to do this kind of crime and
keep over the long term, because people who develop those kinds
of skills become very valuable in the marketplace and may be
easily drawn away from the relatively low-paid positions in
local D.A.s' offices.
Chairman Biden. Let me give you all a statistic and invite
you all to comment on that point, but just a statistic that
relates. There were about five of us who held extensive
hearings in different Committees during the late 1980s and
1990s about the extent of health care fraud, for example.
Depending on whose model you pick, it is somewhere well
above $500 billion and as a high as $1.1 trillion. I mean, it
is a lot of money, it is a lot of money. Some estimates
indicate that the losses to fraud were as great as 10 percent
of--let me be precise. I am sorry. In 1999, health care
expenditures in the United States were $1.1 trillion. I
misspoke.
The estimates are that about 10 percent of that expenditure
was as a consequence of fraud. So we passed an Act that was
called the Health Insurance Portability and Accountability Act,
in 1996, which made funds available for more FBI agents and
attorneys designated specifically to investigate and prosecute
health care fraud cases. We thought this may be a place for
savings because we are worried about Medicare costs.
As a consequence, the FBI, from 1996 on, increased the
number of agents assigned to health care fraud from 112, in
1992, to 500 in 1999. The number of active health care fraud
investigations increased from 592 to over 3,000, and
convictions increased from 116 to 548.
Now, while these numbers are impressive, we should
obviously be cautious about how we interpret this data in terms
of how it relates to other things. But I cite that to indicate
what I know you know, Mr. Comey, and others that this is not
the first time that this idea has crossed my mind about the
possibilities of how to do this. I think it is more complicated
here, but it is just something I wanted to raise with you.
Does anyone want to comment on anything that has been said
so far? Mr. Skolnik?
Mr. Skolnik. Mr. Chairman, I would like to comment on the
question you asked regarding the possible reluctance of local
prosecutors or investigators to take on a case when it may
involve a prominent citizen or a corporate citizen within their
community.
It is my impression that local and state prosecutors or
enforcement agencies are more apt to be constrained by a lack
of resources than any local pressures in terms of why they
don't bring a case. For example, I have always made it very
clear to my staff that we don't shy away from a case just
because it involves a prominent member of the community or a
local corporate citizen. I think that is something generally
law enforcement throughout the country does very well.
If I may differ with my fellow Hoosier here, Professor
Bowman, I do believe that, if appropriately funded and provided
adequate resources, local and state prosecutors and
investigative agencies such as mine can do the job in terms of
developing and investigating white collar crime cases.
Chairman Biden. I would connect the two comments you made
and again invite comments on this. I would connect the lack of
resources and the reluctance to go after the big fellow because
you don't want to wound the bear. It is one thing if you go
after somebody who is viewed as a charlatan in the community
and is not responsible for the employment of a lot of people.
And you are not sure you have the investigative tools to get
the job done, but there is a tendency to be willing to start
it.
But if you don't have the investigative tools and if you
don't have the resources, you sure don't want to go after xyz
corporation, where the corporate leadership sits on the board
of the cathedral and the symphony or whatever. That is all I
meant. I wasn't suggesting that I think local prosecutors or
regulators sit and say, oh, my God, I don't want to take on xyz
corporation.
I just think it is related to resources because like I
said, you just don't want to miss. If you miss with somebody
who already doesn't have much standing in the community, then
the criticism to you and your department is much less severe
than if you take on an entity that is a vaulted entity. That is
all I meant. I wasn't going to motive about resolve or
political courage.
Mr. Comey, you indicated and accurately stated that every
U.S. Attorney's office sets guidelines that direct its
attorneys' prosecutorial decisions. For example, in many
instances these guidelines contain dollar amount limits that
effectively discourage prosecution of economic crimes that
result in dollar losses below a certain amount.
That is a legitimate thing for the Federal Government to
do. I mean, we shouldn't be handling every nickel-and-dime
crime. I am not suggesting that, but I want to make sure we
know what we are talking about here. Let's say the dollar
amount is $100,000.
Investigators take their cues from prosecutors' offices. If
a case will not be prosecuted, you don't have the FBI or the
local folks in that area investigating the case. So I am
concerned about the type and the number of cases that, as a
consequence of decisions not to prosecute, potentially fall
through the cracks. It may be a case much bigger than $100,000,
but if it just appears on the surface that that is the extent
of the loss, the investigation that may uncover a greater
cancer out there is not undertaken.
A $100,000 loss to the two people who were here in front of
us today--granted, they are part of a larger whole, but a
$100,000 loss to them is the beginning, middle, and end of
their existence, in their view, but may not be significant
enough to get us into the deal. It is these relatively smaller
dollar amount frauds that are the most widespread out there.
Hopefully, pray God, we will not find out that they are all of
Enron proportion not in terms of guilt, but in terms of
dollars.
So what happens in the cases that don't get the attention
of federal prosecutors? Are they picked up by State
prosecutors?
We always talk about it going one way. We on the Federal
side, people like yourself and my staff members who were
prosecutors and my son, talk about the local authorities coming
to them saying, hey, look, this is a big deal, we need your
heft here.
But how often do we go the other route? How often does,
say, an FBI agent or an investigator come to a U.S. Attorney or
an Assistant U.S. Attorney and say, look, I think we have got a
scam going here and they are defrauding a whole lot of people,
but is not prosecutable under our guidelines here? How often
does somebody pick up the phone and call the district attorney,
the county attorney, the county prosecutor, the State
prosecutor?
Does the question make any sense here?
Mr. Rosenzweig. In my experience, when I was with the
Department of Justice, it was a fairly common two-way street. I
think, frankly, it will depend a great deal upon the particular
relationships between a U.S. Attorney and a county prosecutor
in various localities, which could easily turn on a whole host
of factors that are utterly unrelated to the merits.
On a number of occasions that I found cases that didn't
seem to warrant Federal concern, where I found there were still
apparent violations of State and local law, both I and the
investigators I worked with were happy to put them over.
Chairman Biden. Does anyone else have a view on that?
Mr. Comey. Mr. Chairman, that is my experience, as well,
both in a small U.S. Attorney's office and now in a very big
one, that there are often cases moving in both directions. The
Federal prosecutors need to be sensitive in doing it because
they don't want their State colleagues to think that a smelly
dog goes to the State and something that is significant goes to
the feds.
Every good U.S. Attorney's office uses those guidelines as
just that, guidelines. If the FBI says what you just said,
which is there may be a lot of victims here and it may go
farther, any AUSA worth his stripes is going to take that case,
regardless of what the loss amount looks to be on its face.
Chairman Biden. I have trespassed on your time a lot here.
I promise you will be out of here by one, okay? It is ten of.
What about this notion of resources? Everyone I have ever
spoken to comes back to a place where they say, hey, look, the
more complicated the case, the greater the resources needed.
Look, let's face it. You guys have a problem right now and
it is not of your doing. We are reallocating--and we should, no
disagreement--a lot of investigative resources to terrorism. At
the same time, if you are able to overcome the disagreement
with the paradigm that the Federal Government should be
involved in local law enforcement through a crime bill and
through funding cops, et cetera, we are also cutting
substantially, essentially eliminating, money for local law
enforcement.
You are going to have fewer cops. You are going to have
less money for Byrne grants. You are going to have less money
for investigative tools on the law enforcement side;
considerably less, I might add, about 80 percent fewer dollars,
flowing from the Federal level directly to hiring of cops, et
cetera.
At the same time as we pull 570 FBI agents, or whatever the
number is, out of violent crime task forces, which your guys
rely on a lot--I mean, they have been very helpful and you have
done very well, in my view, at Justice--I think we have a
resource problem that is further complicated by the plight our
country faces now in dealing with terror and terrorism.
So I am a little concerned here--this is kind of above all
of our pay grades here, but I am a little concerned that we
continue to think we can do more with the same resources. That
is the argument being made, by the way, today by many: We
really don't have to increase the number of FBI agents, we
don't have to increase the number of DEA agents, we don't have
to increase the number of CIA agents; we just do it better and
we are going to cover all of these areas.
So when you take whatever the number is, 500-plus, FBI
investigators out of violent crime task forces and other
areas--they are obviously not going to white collar crime and I
am not arguing they shouldn't go to terrorism--and the FBI
makes the judgment that we are not going to be in the business
of dealing with local law enforcement issues as much as we did
before--i.e., interstate car theft, bank robbery, et cetera,
local issues--and we are not going to fund to the tune of well
over $1 billion a year local law enforcement any longer, if
that prevails, I think we have a problem sitting here talking
about white collar crime resources.
Can my staff put up the number of white collar crime cases?
If you look at the number of white collar crime cases
referred by the FBI since 1993, it has dropped from 21,000 to
under 13,000. Now, that may be because there is a lot less
white collar crime out there. My instinct tells me that is
probably not true. I have no data to prove that is not true.
I see you looking as if that may be wrong.
Mr. Bowman. I don't know whether it is wrong or not. It
strikes me as an odd graphic only because last night I was
looking at the number of convictions reflected in Sentencing
Commission data between 1992 and the present, and although the
number hasn't gone up by a lot, it has gone up. So I think you
have about maybe 2,000 more convictions in the year 2000 than
you did in 1992 for crimes broadly under the economic crime
rubric.
Chairman Biden. Well, it may very well be that with the
21,000 cases--this is what I am trying to get at here--the
21,000 cases referred in 1993 were so complex they couldn't
make the case and they have gone down to 13,000 because now
they are taking much less complex cases and increasing the
allocation of resources available to focus on those cases and
make the case.
Again, I ask staff, is there any doubt that this statistic
is correct? And there is that old admonition that there are
three kinds of lies--lies, damn lies, and statistics.
This statistic is correct, and the only explanation I could
come up with because I am aware, also, that the number of
convictions is up, is it is very possible that there is more
cherry-picking going on here, that we are picking those cases
that are easier to make, or are hard to make, but we have fewer
resources focusing on them.
But the bottom line is either one of two things has
happened--or three. The statistic is wrong, number one. Number
two, the cases that were being referred were frivolous in 1993
and we are now down to a realistic area. Or, three, there has
been a conscious decision to only refer cases that reach a
certain threshold and allocate the resources to the cases that
reach that threshold. There may be other explanations, but
there needs to be an explanation, it seems to me.
Now, the percentage of offenders receiving probation in
fiscal year 2000--again, we are talking the percentage
receiving probation. We are not talking about those who got
sentenced, whether the sentence they received is as disparate
as the probation is.
But as I understand it--and this is at the Federal level,
the Federal Sentencing Commission--1.5 percent, robbery; 5.2,
immigration; 7.8, burglary; embezzlement, 41 percent; fraud, 33
percent; larceny, 56 percent. For larceny cases, for example,
before the Federal Government, under the Sentencing Guidelines,
56 percent of them convicted of larceny got probation.
Now, again, I am not looking to make a case. I am looking
to explain the circumstances because I am going back to this
notion that if the public thinks that the system is not fair,
that people who steal from them are not getting the same kind
of time if they wear a white collar--and it is not necessarily
all white collar, although most of it, I suspect is--are not
getting the same treatment as somebody who burglarizes their
home, then there is a bit of a problem.
Yes?
Mr. Rosenzweig. Well, I have the same data. First, in
general, that is right. I think it is important to note that in
defining the number of people who have gotten probation in the
white collar area and in the non-white collar area, the data
you present combines the number of people who get only
probation with the number of people who get both probation and
a term of confinement.
Chairman Biden. Important point.
Mr. Rosenzweig. So it slightly overstates in all six things
the number of people who are receiving straight, pure
probation.
Chairman Biden. The same standard was applied to all,
though.
Mr. Rosenzweig. Yes, the same standards apply to all.
Chairman Biden. But it is an important point.
Mr. Rosenzweig. So as a gross number, it is a bit
misleading as a gross percentage. The other point I would make
is that I think this goes back to what I was testifying about
earlier, which is from my perspective the real reason that
there is a very low number in the non-white collar area is that
the guidelines prohibit probation for most of those offenses
and they make it available in a large number of white-collar
offenses.
Chairman Biden. Which is the larger point. The other point
here is that according to the 2000 Sourcebook for Federal
Sentencing Statistics, the mean in terms of months for robbery
is 108.1 months; for burglary, 26.5 months; auto theft, 46.6
months; larceny, 7.9 months; fraud, 13 months; embezzlement,
7.2 months.
So, again, the point Professor Rosenzweig was making: It
may fall to us here and/or the guidelines, not to the judges,
as to whether or not this discrepancy exists, to the extent
that it exists.
What I am going to do, in the interest of keeping my
commitment to you on time, is submit some questions to you, if
I may, not a lot, to try to flesh this out a little bit more;
that is, this notion is it really, in fact, appropriately
balanced here.
Lastly, one of the things we didn't speak to and I would be
interested in your comments on--and I will let you go with
this--is you gave us mean numbers for the Nation nationally and
the extent to which discrepancy exists. But if we look at the
Federal fraud offenses from various districts, the districts
vary widely.
Now, I don't know enough to tell you whether or not these
fraud offenses vary so widely because the enormity of the
offense varies widely. Do you follow me? I don't know enough to
know that at this point. That may be part of it. Again, this is
not to make a case; this is to raise a question.
For example, in Rhode Island, the average in terms of the
number of months for Federal fraud convictions in 2000 was 12
months. In northern Indiana, it was 32 months. Again, we may be
comparing apples and oranges. I would like to just take Rhode
Island and Indiana, just those two jurisdictions, and I am
going to ask my staff to go back and compare the type of fraud
offenses and whether or not they are the same, on balance.
I will start with you, Mr. Comey, as the guy who has folks
all over the country in every jurisdiction. Do you find that
there is a difference, that the standards vary fairly
considerably?
Mr. Comey. In terms of intake of cases?
Chairman Biden. In terms of average prison terms for
similar cases.
Mr. Comey. My sense is that it does. It may be a number of
people contributing to that, including the court. There are
number of circuits in this country that depart at a much
greater rate than my former circuit. For example, the Fourth
Circuit; you don't get a downward departure in the Fourth
Circuit.
But it may also, as you pointed out, Senator, depend upon
the case mix. It may be that certain jurisdictions are
responding to a rash of small embezzlements by tellers, and so
there have been a lot of fast-track bank cases. Indiana may
have done a couple of huge cases and devoted their resources to
that.
Chairman Biden. There are a number of reasons this
departure could take place, and that is why I am going to
submit these questions. The number of cases prosecuted in Rhode
Island, for example, is only 18. The number of cases prosecuted
in, for example, the Western District of New York was 48.
Larger districts have larger budgets that enable them to have
special task forces. The paucity of white collar crime and the
predominance of other threats in certain districts.
So there are a lot of reasons, but I guess what I am trying
to do here--and I hope it is obvious to you because I know this
is a very serious panel--is trying to do this in a sober and
thoughtful way so that we don't have a cure that is worse than
the problem out there.
I am a cosponsor of S. 2010. I agree with you that it makes
some good sense, but I think, if nothing else, one of the jobs
that we should exercise here is to educate the public. If it
turns out that there isn't this vast discrepancy as perceived,
then we should let people know that, again because I think it
is very important that there is this sense of the average
person thinking the system is fair and the system treats people
equally and equitably.
So this is just our first hearing. This is not going to be
dragged out for any extended period of time, but I have to
figure out where the inequities lie here, and in the process,
if it turns out there is not this vast discrepancy, then make
sure the public knows it and the press knows it so that we can
reinstate some confidence in the system, and if there is a vast
discrepancy, fix it.
I have some questions for my two colleagues from Indiana
and West Virginia, who have positions of authority there, that
I will put in writing relative to resources and whether or not
you think there is any Federal role that we have here.
I also am going to ask you, Mr. Comey, some questions,
obviously you will have to kick upstairs, about resources at
Justice. And I am prepared to ask all of you this--I don't want
to put work on you, but I would ask the two colleagues at the
end of the table here, Mr. Bowman and Mr. Rosenzweig, about the
notion of deterrence.
Again, the general impression most people have is a white
collar criminal is usually deterred by their first offense, if
they get jail. And the argument I have heard often, and I have
heard prosecutors make it, is, hey, look, this person had
standing in the community and the mere fact that they have been
convicted is enough of a deterrence and they are never going to
do it again, even though they don't go to jail, whereas you may
have to put the guy who clunked somebody on the head and took
their wallet in jail for a long time because he has done it
three more times and the recidivism rate is so high. That is
why we make the penalty higher.
So I have some questions drafted and I would like to talk
about deterrence, recidivism, and severity of the punishment,
and whether there is or should be a relationship. I am going to
ask that to the Justice Department, as well.
I am sorry. It is eight minutes after, but I apologize. I
am truly thankful that you all are here. You are first-rate
panel, and with your permission I may trespass on your time
again before this is all over, if you are willing. Gentlemen,
thank you very, very much.
There is a statement for the record by Senator Breaux, who
is Chairman of the Special Committee on Aging. He has been
engaged in issues that relate to the elderly population. I want
that in the record.
Senator Grassley has a statement, as well, and some
questions.
We also have statements by Senator Leahy and Senator Hatch.
And they may, I warn you, have a few questions for you, but we
are not going to try to make too much work for you.
We are adjourned.
[Whereupon, at 1:09 p.m., the Subcommittee was adjourned.]
[Questions and answers and submissions for the record
follow.]
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PENALTIES FOR WHITE COLLAR OFFENSES: ARE WE REALLY GETTING TOUGH ON
CRIME?
----------
WEDNESDAY, JULY 10, 2002
United States Senate,
Subcommittee on Crime and Drugs,
Committee on the Judiciary,
Washington, D.C.
The subcommittee met, pursuant to notice, at 2:34 p.m., in
room SD-226, Dirksen Senate Office Building, Hon. Joseph R.
Biden, Jr., Chairman of the Subcommittee, presiding.
Present: Senators Biden, Durbin, Grassley, and Sessions.
OPENING STATEMENT OF HON. JOSEPH R. BIDEN, JR., A U.S. SENATOR
FROM THE STATE OF DELAWARE
Chairman Biden. The hearing will come to order. We thank
our witnesses for being here, and those in the audience.
Senator Grassley and I are each going to make relatively brief
opening statements and then turn it over to our witnesses.
We are now in a period of, I guess it would not be an
exaggeration to say, if not a major, a minor reevaluation on
how we do business in America. The thing that I would like to
point out before I begin this hearing is this is not merely
about stockholders who have been defrauded. This is not merely
about employees who have lost their jobs. This is not merely
about the wrongdoing of individuals. Quite frankly, and it is
not hyperbole, this is about the capitalist system. It all
rests on the notion of transparency, period.
If, when you go to purchase a stock, you do not have any
reliable public information that gives you an ability to make
an educated guess as to what the prospects of that company are
based on its assets, its liability, its product, the market,
the time, the environment, then you might as well go play the
lottery instead of buying stock. Go play the lottery.
It is not an accident that Europeans are for the moment
disinvesting in this country. It is not an accident that the
American Business Roundtable, the sort of bogeyman--not in my
State, the corporate State of America, but the bogeyman of sort
of the conspiratorial theories, the trilateralist opponents
kind of thing--it is not a mistake that the Business Roundtable
sent a letter to me.
``Dear Senator Biden, I am writing on behalf of the
Business Roundtable to urge you to vote for Senate bill S.
2673, the Public Company Accounting Reform and Investors Act of
2002.''
This didn't come from the Consumers Union of America. This
didn't come from a group of new world, new order types. This is
the establishment of the established business interests in the
world, and they have it right because guess what? There have
been an awful lot of driveby shootings.
You have companies as old, as honorable, and as sound as
the DuPont Company opening up their 200th stockholders meeting
and an honorable guy, chairman of the board, starting off by
saying ``By the way, I want to make it clear to you we aren't
one of those guys. Think of that, think of that.''
So we need to look at how this economy is run. The problems
we confront range across the width and breadth of business
activities. We have Enron, WorldCom, Martha Stewart, Xerox,
Rite Aid, all in varying degrees of collapse or difficulty, and
the list goes on and on of people and corporations admitting
cooking the books or being accused of inside deals.
We need to ask, as someone else said, are the capitalists
killing capitalism? I expect the dialogue to last beyond this
session of Congress. Everyday, people come up to me in my State
and say, ``Joe, you have to do something.''
If I ever thought, Senator Grassley, that I would be going
to Fourth of July parades in my State--this is the God's truth,
and you probably experienced the same thing--whether it is in
Hockessin, Delaware, or down in Laurel, Delaware, and people
saying to me, ``You know, I own stock in my 401(k).'' These are
blue-collar workers, not just white-collar workers. ``I lost
this, that, or the other thing. What are you going to do about
those guys?''
I haven't had this much spontaneous concern expressed to me
and calls for penalties for wrongdoers, as the President might
say--I haven't had this much since the beginning of the drug
epidemic in this country.
Everyday, as I said, people want to know what we are going
to do. They are concerned about a climate of corporate greed
and overreaching and what appears to be the loss of an ethical
framework in some American corporate board rooms. They are
concerned about corporate stock options, the vast amount of
money executives make, and the way incentives are structured
for CEOs to walk away from failing companies.
I support Senator Levin's legislation, which requires stock
options to be clearly listed as a corporate expense, a position
already endorsed by Alan Greenspan and Warren Buffet.
Delawareans are concerned about how our tax treaties are
written to give inappropriate encouragement to companies to
move overseas to avoid taxes. I listened to a Wall Street
analyst as I was shaving, leaving my house this morning, on
CNN, who was asked about the President's speech. The response
he gave was, you know, we have created--how do you phrase it--a
climate for corporate greed. This was a Wall Street analyst.
As my mother would say, and the nuns that taught me, Joe,
you have to avoid the occasions of sin. They usually meant
girls back then, the nuns, but the truth of the matter is we
present a lot of occasions of sin for corporate executives. The
incentive that we place before them is one that the vast
majority resist, but it is to take actions that are
counterintuitive to the interests of their stockholders.
Delawareans are concerned about providing more transparency
and accountability so when you want to buy a stock that is a
good, safe investment, you know the books aren't cooked. That
is why I support Senator Sarbanes' bill, as the Business
Roundtable suggests that we should, that is on the floor today.
If you are an employee, you need to know that your pension
is safe, and if there are real hard criminal penalties if it is
not, then you have got a better fighting chance that it stays
safe. That is why I joined Senator Leahy in offering an
amendment to strengthen the criminal penalties for what are now
white collar crime misdemeanors. So if you steal a pension, you
go to jail, no different than if you steal a car.
I live about 2 miles from the State line and if you steal a
car out of my driveway and you drive it across into
Pennsylvania, 10 years, Federal guidelines. If you take a
pension by violating ERISA, the Federal system to safeguard
pensions, misdemeanor, maximum one year. The pension may be
worth $1,800,000. My car may be worth $2,000, and if you saw
the car I drive, you would know why I say that.
Today, we are voting on the floor of the Senate to address
a lot of these concerns, specifically honesty and
trustworthiness of the reports that are provided by accounting
firms about what is going on inside corporate America.
I will offer an amendment today to restore the power of
stockholders to bring lawsuits against executives who distort
and inflate the value of their company, misleading investors
and setting them up to fail. That is why it is so important
here today that we hear from witnesses who will help us examine
many of the issues in terms of criminal and civil enforcement
of the laws governing how we do business, and we do have a
very, very distinguished panel for that purpose.
Before I introduce them, I will yield to my colleague from
Iowa, Senator Grassley, for any comments he wishes to make, and
then we will go with the witnesses.
STATEMENT OF HON. CHARLES E. GRASSLEY, A U.S. SENATOR FROM THE
STATE OF IOWA
Senator Grassley. Mr. Chairman, I wasn't in any parades
over the holiday week recess, but I did have town meetings in
14 counties of northwest Iowa and this issue did come up at
many of those meetings, if not all of those meetings, because
it was on people's minds.
First of all, I want to make very clear that I appreciated
the President's speech yesterday. For those who have been
somewhat critical of it, I want to suggest that the President
did not say that there were any ideas before Congress that he
would oppose. Now, he might oppose some. I don't know, but he
didn't that there were any before Congress he would oppose.
Obviously, he suggested a lot of legislative responses
himself, and I think the President is going to feel comfortable
signing legislation that we pass. I have never seen the
President not willing to listen to Congress and work with
Congress on this issue. So I applaud the President for speaking
out and setting a very, very good tone.
We have listened about this issue in a previous hearing and
we have had the issue raised about white collar crime, whether
or not criminals are punished less severely if they are white
collar criminals than other criminals. Many legal scholars and
others believe that white collar offenders are rarely
prosecuted. We need to get to the bottom of this and ask why
and what we can do about it.
I think a message needs to be sent that white collar crime,
especially as it relates to fraud, is serious and carries
significant penalties. This is an area where we need to be even
tougher on criminals. I am very happy that the President is
taking the lead in setting up the Financial Crime Swat Team,
because this means that the President is not going to wait for
Congress to act before he can do what he can under his own
authority and what the Justice Department can do.
I also want to emphasize that we need to look into the
problems of accounting standards and business ethics systems.
There needs to be a revival of business ethics in today's
corporate world, and legislation that we pass will not
guarantee that. It will guarantee punishment when things that
are criminal happen.
But we need to have, as evidenced by the letter the
chairman has referred to, as well as ads that were in
yesterday's Post, as an example, business leaders themselves
see that there is a real need for people at the top of the
business world to set good standards, and a promise from those
people that are involved with those ads, at least, that there
will be that leadership to do that.
Now, I want to concentrate on one last point more in depth
than the three or four things that I have mentioned, because
this is something the chairman knows I really believe in.
Most of the time when I talk about whistleblowers, it is in
regard to government service and people that are in public
service blowing the whistle on wrongdoing. But I think one
important way to protect investors is to ensure that corporate
whistleblowers will be protected from retaliation when they go
public with knowledge of fraud.
For nearly two decades, I have come to appreciate and honor
whistleblowers, not meaning that everybody that comes before
Congress or before me has a legitimate position. But I think
that we need to be open to at least listening to what those
positions are because there is an awful lot to learn. Only
whistleblowers can explain why something is wrong and provide
evidence to prove it. Then we can fix the problem and hold
miscreants responsible.
Only whistleblowers can help us understand the culture that
produces wrongful behavior. Understanding the culture is the
key to fixing the problem and realizing meaningful
institutional reform. In that regard, I consider whistleblowers
national assets.
In the context of corporate wrongdoing, whistleblowers can
provide the evidence that prosecutors need to build a case
against corporate criminals. Without these brave men and women,
prosecutors would lack an important tool in their efforts to
curb corporate fraud.
It is for these reasons that I have worked to provide
protections for corporate whistleblowers, as well as Federal
Government whistleblowers, who are retaliated against for
exposing fraud, waste and abuse. Because whistleblowers are so
important to cracking down on corporate fraud, I asked Mr. Tom
Devine, from the Government Accountability Project, to come and
testify, and I will wait for him to summarize what he has to
say.
Mr. Chairman, I didn't read my entire statement. I would
like to have it all put in the record.
Chairman Biden. It will be pleased in the record.
[The prepared statement of Senator Grassley appears as a
submission for the record.]
Chairman Biden. Let me introduce our first panel and
welcome back Mr. Chertoff, who is the Assistant Attorney
General in charge of the Criminal Division of the Department of
Justice.
He has served as U.S. Attorney for New Jersey from 1990 to
1994, and before being nominated to his current position he was
a partner in Latham and Watkins. Mr. Chertoff is a graduate of
Harvard University undergraduate, as well as the law school, a
man who knows of what he speaks.
I kidded him before we began by saying it is a good time to
have this job. What is that old curse? May you live in
interesting times. You are in interesting times. We thank you
for being here and we appreciate the balance you always bring
to this committee.
Mr. William W. Mercer is the United States Attorney for the
District of Montana and head of the Department of Justice's
White Collar Crime Working Group. Mr. Mercer had seven years of
experience as Assistant U.S. Attorney before he became the U.S.
Attorney. He has an undergraduate degree from Harvard, and also
a law degree, and we welcome him here as well.
Gentlemen, the floor is yours, if you will proceed in any
order you would like to. Michael, you fire away.
STATEMENT OF MICHAEL CHERTOFF, ASSISTANT ATTORNEY GENERAL,
CRIMINAL DIVISION, DEPARTMENT OF JUSTICE, WASHINGTON, D.C.
Mr. Chertoff. Thank you, Mr. Chairman, Senator Grassley. I
would like to thank you for inviting Bill Mercer and myself to
appear here. Bill is also the chairman of the Subcommittee on
Sentencing of the Attorney General's Advisory Committee of U.S.
Attorneys. Both of us welcome the opportunity to appear today
to continue the discussion about what this administration has
done, is doing, and intends to do to detect, punish, and deter
white collar crime.
Yesterday, the President travelled to New York and called
for a new ethic of corporate responsibility. Although most
business people do play by the rules, some do not, and we are
reminded again recently of the serious damage to people's trust
and confidence in our economy that this type of wrongdoing
fosters. The President's proposals would give prosecutors
important new weapons in the fight against this kind of white
collar crime.
As I know you are aware, we have not hesitated at the
Department of Justice to proceed with criminal cases against
corporate executives, accountants, and others who have abused
their positions of trust and authority for personal gain or for
other improper purposes by breaking the law.
Indeed, until recently some people were calling us too
aggressive in pursuing these criminal cases. Not surprisingly,
those voices of criticism seem to be growing more faint as
evermore egregious business practices are exposed to public
scrutiny.
I am proud of the work we have done and continue to do both
here in Washington and at the many U.S. Attorneys' offices
around the country, where Justice Department prosecutors and
FBI agents are going after corporate crooks everyday. We have
made a lot of progress, but we have a lot left to do.
In the meantime, this administration is sending a very
clear message: fraud, obstruction of justice, and other types
of criminal activity in the business world will not go
unpunished or receive merely a slap on the wrist. To the
contrary, robust enforcement of the law gives people both on
Wall Street and Main Street confidence that the financial
marketplace and our economy in general will continue to operate
under principles of honesty, integrity, and trust. That is a
message that most honest, hard-working people in the business
community have welcomed and one that will give the American
people renewed faith in our economic system and our criminal
justice system.
The President's proposals would both increase the ability
of agents and prosecutors to catch white collar criminals and
stiffen the penalties for offenders when they are convicted.
Let me take a moment to highlight some very specific proposals
as they relate to criminal law enforcement.
First, the President has ordered the formation of a
corporate fraud task force within the Department of Justice
which will be chaired by the Deputy Attorney General and of
which I will also be a member. The task force will provide
direction for the investigation and prosecution of white collar
crimes, including significant cases of securities fraud,
accounting fraud, and other financial misbehavior. The task
force will also actively work to improve cooperation with other
Federal agencies and State authorities, and will recommend
policy and legislative changes as appropriate.
Second, the President has called for increased white collar
penalties, including measures to ensure that prison sentences,
substantial ones, will be the rule rather than the exception in
significant criminal cases. Swift and certain punishment of
financial crimes is vital to the prosperity of the U.S. and to
people's faith in the system.
We recommend increasing the available penalties for mail
and wire fraud, the two the statutes that govern most basic
forms of white collar crime. Too often, the public believes
that business criminals receive relatively lenient treatment in
court, and unfortunately I think there is some truth to that.
Not only are the maximum statutory penalties for fraud and
other white collar-type offenses significantly less overall
than those for violent offenses or drug cases, but it appears
that judges in some jurisdictions are sometimes too willing to
depart downward from the mandated Federal sentencing guideline
range to sentence white collar offenders to minimal, if any,
jail time or home detention, or even probation.
We strongly oppose lenient treatment for white collar
criminals. The bottom line is that white collar criminals are
just as much criminals as those who steal with a gun or a
knife. They do real harm to people, they ruin lives. Jail time
performs two functions. It holds these white collar criminals
accountable for their past misdeeds and it prevents future
misbehavior by those executives who might toy with the idea of
beating the system.
Third, the administration's proposal would provide
regulators, investigators, and prosecutors with enhanced
investigative tools. As you know, investigating white collar
fraud cases is very challenging and resource-intensive. Often,
the critical evidence is to be found among e-mails or
accounting memoranda of the corporation and its advisers.
Without that documentary or electronic evidence, uncovering the
footprints of fraud becomes a virtually impossible task.
Accordingly, the President's proposal would both simplify
and toughen the law against obstruction of justice,
particularly document shredding and destruction. Under the
current statute, some courts have ruled that the Government can
only charge someone for persuading others to engage in
obstruction of an anticipated official proceeding. If a person
acts alone, no matter how egregiously, he or she cannot be
prosecuted unless a proceeding is actually begun. The President
has asked Congress to clarify this law so that it unambiguously
punishes all individuals who seek to interfere with law
enforcement by removing or destroying evidence.
Although we look forward to being able to use the new tools
the President has proposed, we are proud of this
administration's record of vigorous enforcement of the laws
against white collar criminals. I am sure the committee
understands I am prevented from discussing pending cases in
detail. And, of course, I can't reveal information about non-
public investigations. But I can make reference to several
major corporate investigations which have become public.
WorldCom: The Department of Justice is currently reviewing
the facts behind WorldCom's recent disclosure that it had
improperly accounted for $3.9 billion in expenses.
Enron: In January, we set up an unprecedented national task
force to investigate the collapse of Enron. The investigation
has so far led to the jury conviction of the accounting firm
Arthur Andersen for obstructing justice in connection with an
SEC investigation of its client, Enron. Furthermore, the global
managing partner in charge of the Enron engagement team, David
Duncan, has been convicted by plea of guilty to obstruction of
justice in April. He will be facing sentencing in the near
future. More recently, three bankers were recently indicted
based on allegations of a multi-million-dollar fraud scheme
arising out of one of the Enron-related partnerships. This
Enron investigation is active and ongoing.
AllFirst: The United States Attorney in Maryland recently
obtained a seven-count indictment against a former AllFirst
Bank currency trader, alleging among other things, bank fraud
which resulted in the loss of more than $691 million.
ImClone: The U.S. Attorney in Manhattan is currently
investigating allegations of insider trading with regard to
ImClone Systems, Inc. You will recall that the former CEO,
Samuel Waksal, was arrested last month and charged with insider
trading.
Rite Aid: On June 21, the U.S. Attorney for the Middle
District of Pennsylvania announced criminal charges, including
mail and wire fraud, against five former and current officers
of Rite Aid Corporation, the drug chain, including the former
CEO. Those charges involved an accounting scheme that led to a
$1.6 billion restatement of income. I think at the time it was
the largest. It has since unfortunately been superseded. It has
become one of the largest in U.S. history. One defendant has
pled guilty.
In closing, I want to thank you, Mr. Chairman, and the
committee for your leadership and the spirit of bipartisan
cooperation you have brought in addressing the challenges of
rooting out, punishing, and preventing white collar crime. The
President's proposals in this area will greatly enhance the
Department's ability to enforce the laws and ensure that
criminals who violate their trust in operating businesses face
stiff penalties, including jail time. We look forward to
working with you and the committee as we encourage a new ethic
of corporate responsibility in this country.
Mr. Chairman, that concludes our prepared remarks. I ask
that the full text of my remarks be entered into the record of
the hearing, and both Mr. Mercer and I would be happy to answer
any questions the subcommittee has.
Chairman Biden. It will be placed in the record, and again
I thank you both for being here. We will do ten-minute rounds.
There are only three of us here at this moment.
Let me begin by saying that one of the things I want to
explore with you, Michael--and I just want you to know I am not
picking on you or anybody, but I think you at the Justice
Department Criminal Division, as well as the FBI, are really
strapped. I mean, you are really in a bind, unrelated to what
new laws or any amendments to sentencing we propose or you
propose, and that is the administration's increasingly
understandable use of the Justice Department to fight terror,
the FBI's decision understandably to take 518 folks out of the
criminal justice area dealing with violent crime and white
collar crime, the fact that since 1993, in the Clinton as well
as in the first year of the Bush administration--in 1993,
according to the transactional records access clearinghouse at
Syracuse University, the FBI referred 20,893 white collar crime
cases. In the year 2001, the number of referrals was down to
12,000.
That doesn't mean you don't still have a heck of a handful
here, but the idea of focusing on white collar crime has been
diminishing for some time. Now, we come along and we tell you
you have fewer resources and more responsibilities. So I am
going to be asking you all back here at some point and telling
you you need more money, you need more staff.
Now, you are going to tell me, because you are a good
Republican, and as my friend here will say, you can do more
with less and you just have to order it better. That is so much
malarkey, I am tired of hearing it, and I eventually will
convince you that you need more help because, as Barry
Goldwater used to say, in your heart you know you do. But
having said this, you have a real full plate here.
By the way, I ask unanimous consent that I be able to
submit to the record Mr. John T. Dillon, the Chairman of the
Business Roundtable, his letter to me calling for tougher laws
and supporting the Sarbanes legislation.
I might add, Michael, and to my friend, Senator Grassley,
one of the reasons why people in the business community on
``Moneyline,'' not on ``Geraldo,'' were criticizing the
President yesterday is they fully expected he was going to
embrace this and he was at least going to go as far as the
Business Roundtable would go.
It is true he didn't say he wouldn't, but there is an old
expression, people vote with their feet as to what they like
and don't like. Well, investors vote with their money. The Dow
is down another 167 points today. As the President was
speaking, the ticker was going click, click, click, down 173
points.
The language was tough. For example, he called for
increasing the budget for the SEC by 29 percent. There is
bipartisan support here to do it by 77 percent. He called for
making it illegal to shred documents. We all agree with that,
but nothing on insider loans, nothing on the accounting
industry in terms of specifics, nothing on separating analysts
and underwriting in the investment banks. But I think and I
hope that he will support some of the things that we are
proposing.
On the floor as we speak--and I may have to leave to go
offer my amendment--is a bill that many of us have cosponsored,
Democrat and Republican. I think Senator Durbin is a cosponsor
as well--correct me if I am wrong, Senator--of the Leahy
amendment.
We call for stiffer penalties--and I won't go through all
of that--including a number of things. I have the White Collar
Crime Penalty Enhancement Act of 2002 and I would like to just
question you in my remaining moments on if the Department has a
view on it.
This legislation which I am going to amend--well, if I have
the votes, going to amend the Leahy-Biden, et al, and everybody
else who cosponsored it, bill--calls for a couple of things.
One, it amends the general conspiracy provisions of Title 18.
Under current law, the maximum penalty, as you know, for
general conspiracies to commit a crime against the United
States is five years' imprisonment, while the penalty for the
predicate offense for conspiracy is substantially higher.
So what I do in here--and you may not be prepared to
respond, but what I do in this legislation is I make the
conspiracy, if it sticks, the sentence has high as the
underlying predicate for the crime of conspiracy.
The second thing we do is it amends Title 18, Sections 1341
and 1343, to raise maximum penalties for mail fraud and wire
fraud from 5 years to 10 years. Now, as you all know, if you
take the Enron example, assuming that the corporate leadership
sent out a letter to its stockholders saying the stock is going
to go up $100, like they did verbally say that, they would be
guilty of mail fraud, if you could prove it, and it increases
that penalty.
The third thing we do is it amends ERISA, the Employment
Retirement Security Act of 1974, to increase the criminal
penalties. As I said, right now the maximum, if you, in fact,
violate that law, is a misdemeanor punishable by up to one
year. What I do here is amend it to raise the penalty from 1 to
10 years, leaving the Commission the judgment as to what that
would be.
I assume--and Mr. Mercer knows this well--I assume they
would do it based on the law, like you do on theft and like you
do on other things. So if your criminal behavior causes people
to lose $10 million, you are going to go to jail longer than if
the pension loss is $1,000. Also, it directs the Sentencing
Commission to review and amend the Sentencing Guidelines to
provide increased penalties provided under this bill.
Lastly, it creates a new section in Title 18 requiring a
certification to be signed by top corporate executives that
those financial reports they are putting out reflect the
financial condition of the company.
Some will say, well, Biden, that is too tough, but there is
a fiduciary responsibility that exists. In all cases it
requires scienter, and if they could prove that they were
defrauded and they didn't know, then they are not guilty. But
they have to sign it, and if they sign it and it turns out it
is not accurate, they could receive severe penalties.
Have you had a chance to look at any of those, and if not,
will you?
Mr. Chertoff. Mr. Chairman, I received it this morning and
I am very eager to review it. I know from just having scanned
it briefly and from your summary that certain aspects of the
proposal are consistent with what the President said yesterday
in his speech. In particular, the elevation of the penalties
for mail and wire fraud, the directive to the Sentencing
Commission to look at adjusting the Guidelines to take account
of the dangers posed by white collar corporate fraud, and also
the certification requirment are all part of the President's
accountability proposal.
So I certainly look forward to reading this and getting
into the details, and I am sure that we will have comments in
short order from the administration to this proposal.
Chairman Biden. Well, that would be useful. Even though I
am going to try to introduce it today and amend it, I say,
speaking for myself only, even if it is adopted today--if the
administration looks at it and if they agree in substance about
it, but they have a view that it should be altered on the
margins or a tactical difference, I am fully prepared to work
with you, even though it will have passed, in conference to
determine whether or not it should be altered.
So I mean this sincerely. I am looking for your expertise
and this is not something we shouldn't be doing together. But
as you know, things have had a way of getting ahead of us here
and we are moving along fairly quickly. I hope we don't move in
a way that is counterproductive, although what Senator Sarbanes
has in the bill has been well thought-out, a lot of hearings, a
lot of movement.
I have more questions, but let me yield to my colleague
from Illinois and then I will go back to a second round.
Senator Durbin. Thank you very much, Mr. Chairman. I just
have a few questions.
Mr. Chertoff, I looked through your list of prosecutions.
How many officers of Enron have been indicted by the Department
of Justice?
Mr. Chertoff. No officers of Enron to date have been
indicted.
Senator Durbin. None?
Mr. Chertoff. Correct.
Senator Durbin. The decision was made by the Department of
Justice to indict a corporation, Andersen.
Mr. Chertoff. Well, it was a decision by the grand jury,
actually.
Senator Durbin. Certainly, there was some guidance from the
Government.
Mr. Chertoff. I would say that it is normally the case that
when matters are presented to the grand jury, it is with the
guidance of the Government.
Senator Durbin. The question I have is when the Government
considered the indictment of the corporation rather than the
wrongdoers, did the Government envision that a successful
prosecution would close the corporation and cost 20,000 to
25,000 people their jobs?
Mr. Chertoff. Well, let me try to clarify this a little
bit, bearing in my mind, as I know you know, Senator, that I am
limited in what I can discuss about a pending matter.
First, let me dispel a misconception that I think is
embedded in the question. There has actually been a person who
has been charged and convicted, Mr. Duncan. He was convicted of
obstruction of justice.
Secondly, the penalty for the single-count indictment in
the Andersen case is not going out of business. The penalty is
a fine of $500,000 and possibly probation, and that is the
penalty which Congress has prescribed.
The offense of which this company was convicted is a very
serious offense. I can tell you that we can pass all the laws
in creation. If we cannot find the evidence to enforce the
laws, because people destroy it or tamper with it, we are never
going to make any cases.
So it is very important at the beginning of a campaign
against white collar crime to lay down a simple proposition:
You cannot play with the evidence, you cannot tamper with the
witnesses, and you cannot destroy the evidence. And if you do
those things, no matter how powerful you are or how much
lobbying you do or how many ads you take out in a newspaper, we
will proceed with the full vigor of the law.
Senator Durbin. Of course, that is something that we would
all agree with. Any person in any company guilty of that
wrongdoing should be held accountable under the law. I don't
think anyone would disagree.
The question I asked you was you must have envisioned that
a successful prosecution of Andersen would destroy the
credibility of the company and virtually destroy the jobs and
livelihoods of thousands of people who were not guilty of any
wrongdoing, didn't shred a document, weren't even close to the
scene of the crime.
Mr. Chertoff. Senator, let me take you back to something
that the U.S. Supreme Court said 100 years ago, in I think it
was the Standard Oil case, which is one of the first cases that
deals with corporate liability for criminal law--as you know,
we have been indicting and prosecuting corporations for at
least the last 100 years.
The principle is this: When people band together and form a
corporation and they set up a leadership for that company, a
management, and they throw their stake in with that, they have
to take the bitter with the sweet. If the company conducts
itself properly, then the profits are rightly distributed among
the employees and the shareholders and everybody else who
benefits. But if the leadership of the company allows the
company or directs the company to commit criminal offenses,
then the company has to suffer that.
I think what was envisioned by the Department of Justice in
pursuing this case against the corporation is what was
envisioned in other cases in which corporations have been
indicted: that we would enforce the law vigorously, seek the
penalties which Congress has mandated, and that we would not be
deterred by arguments that appeal to factors that are
extraneous or outside the law, or by publicity campaigns or by
television advertisements or things of that sort.
Senator Durbin. I happened to meet about 20,000 of those
extraneous factors in Chicago, people who went to work
everyday, paid their taxes, obeyed the law, and were just as
upset as you and I are about the wrongdoing of some people in
their company.
Mr. Chertoff. Senator, let me----
Senator Durbin. Excuse me. Most of those people are out of
work today. Those are extraneous factors.
Mr. Chertoff. Let me suggest, Senator, that the people who
bear responsibility for the consequences of the criminal
offense committed by the corporation or the partnership are
those who led it and those who had the responsibility to make
sure that the law was followed.
When you have a senior partner in a company convicted of
committing a criminal offense and when you have evidence at
trial that indicates the involvement of others, I think the law
has to operate in the way that Congress intended it.
Senator Durbin. To indict the corporation.
There is an old saw that the law in its infinite wisdom
makes it a crime for both the rich man and the poor man to
sleep under the bridge. I would like to ask you on the issue of
mandatory minimum sentences--we have made it clear in Congress,
with the support of this administration, that we are going to
establish mandatory minimum sentences for the sale of small
amounts of narcotics, a thimble full of cocaine.
Do you believe that when we are talking about wrongdoing by
corporate officers, whether it is the destruction of documents,
misleading the public, defrauding the public, that we should
establish mandatory minimum sentences as well?
Mr. Chertoff. I think what the President has said is that
in formulating the Sentencing Guidelines which direct the
judges as to how to sentence that the Sentencing Commission
ought to impose as sentencing guidelines that would require
jail time very serious penalties for corporate officials who
violate their public trust.
Senator Durbin. Mandatory minimum sentences?
Mr. Chertoff. Well, I think the way the Guidelines operate,
if one is observing the rules about departures, federal
sentencing is, in effect, mandatory: the required sentences for
people who commit serious white collar offenses, unless very
narrowly tailored downward departures are appropriate would be
prison time. I think if we have that kind of a regime which the
President has called for, we will have, in effect, required
jail time for big corporate criminals.
Senator Durbin. Do you feel that Congress was mistaken in
1995 when it changed the securities legislation so that the law
no longer allowed suits to be brought by individuals against
corporations for securities fraud? Some have suggested this has
helped to create the climate that has led to this corporate
corruption today?
Mr. Chertoff. Well, I have to say, Senator, first of all
that my area of expertise and responsibility does not extend to
private civil lawsuits against corporations for securities
fraud. I am not sure that I would say that they prevented those
lawsuits.
What I would say, though, is I think our focus, certainly
the focus of the Department, is on enforcement of the criminal
law. Obviously, the SEC has its own powers, regulatory powers
and civil enforcement powers, which it then deploys. So I have
to, I guess, suggest that the issue of private lawsuits is one
that really goes outside of my area of expertise and
jurisdiction.
Senator Durbin. Well, I would just like to suggest to the
committee I think it had a lot to do with it. Those people at
Enron who are now being sued are using as a defense that they
could not be found guilty of aiding and abetting because of the
congressional action on security litigation reform. We are
going to consider that issue in the bill that is presently
before Congress. I just sincerely hope that when this is over
that we will look back and say that the wrongdoers will pay a
price.
Do you have any idea when the first person at Enron may be
indicted for wrongdoing?
Mr. Chertoff. Again, as I think you know, Senator, it would
be a violation of any number of rules and laws for me to start
to predict who might be indicted or when they might be
indicted.
What I can tell you is we have a dedicated, large group of
prosecutors and agents who are making this investigation their
full-time business, and there is a very deep and profound
determination on the part of the Department, including on my
part personally, to see to it that anybody who has violated the
law is going to be punished, whether it be in the case of Enron
or any other white collar offender.
Senator Durbin. Well, I just think it is odd that a
shoplifting actress in Hollywood is facing more time in jail
than any officer in Enron as we speak today, and I hope that
that changes in the near future.
Thank you, Mr. Chairman.
Chairman Biden. Thank you.
I would ask unanimous consent that a statement that I made
in 1995 on the so-called Private Securities Litigation Reform
Act be put in the record at this point. There being no
objection, it is so ordered.
I agree with the Senator from Illinois. I think it has a
gigantic influence. If I am not mistaken, there were only about
eight of us who voted against that at that time.
Senator Durbin. And 99 in the House.
Chairman Biden. And 99 in the House.
Part of what I am about to introduce as an amendment on the
floor is to undo three pieces of the seven major changes we
made in that law. It is out of the jurisdiction of our friend
from the Criminal Division, but I can assure you we will hear
more about it.
The Senator and former U.S. Attorney and a man who, were I
white collar criminal, I would not want to have gone before,
having worked with him for these years, the Senator from
Alabama, Senator Sessions.
STATEMENT OF HON. JEFF SESSIONS, A U.S. SENATOR FROM THE STATE
OF ALABAMA
Senator Sessions. Thank you, Mr. Chairman. I fundamentally
agree with the purpose of your hearings, as I understand it,
and that is we have too light sentences for serious white
collar crime.
I know Mr. Chertoff remembers the arguments 8, 10, 15 years
ago. It was we have got too many people in jail; jails need to
be reserved for dangerous criminals, not for non-violent white
collar criminals. We heard those arguments.
But in the course of that I think we went too far, because
when a person defrauds thousands of people, many of them losing
their life's savings, deliberately and with clear criminal
intent, then that is a serious crime.
Harsh sentencing does deter. I was a United States Attorney
during the Savings and Loan fraud cases. I prosecuted Federal
land bank fraud cases. My office prosecuted those cases that I
supervised, and I am going to tell you there is a lot better
behavior in banking today because people went to jail over
those cases in the past. They lost everything they had, their
families were embarrassed, and a lot of people started checking
to make sure they were doing their banking correctly.
So I kind of have a sense that it is deja vu all over
again, as Yogi says. The CEOs of America somehow felt nobody
was watching. We have gone through a period of unprecedented
growth.
The way these banks got in trouble, Mr. Chairman, if you
will remember, is nobody found them to be cheating and
defrauding until the price of real estate collapsed. While it
was going up, it never revealed itself. It is sort of what is
happening in the corporations today. While everything was going
so great these problems could be covered up, and now they are
coming home to roost.
I do believe in the justice system, which means that every
person is presumed innocent and he is entitled to his day in
court, but I do hope you are working on your team to move
forward rapidly.
Let me just ask you, Mr. Chertoff, in your role as a
prosecutor, as a Former United States Attorney, you have seen
some of these bank fraud cases. Do you see a similarity between
the misbehavior now of corporate America as compared to what we
were seeing in the late 1970s and early 1980s with the Savings
and Loan community?
Mr. Chertoff. There is a similarity, Senator, because we
went through a wave back, I guess, 10 or 15 years ago where
there were a minority, but nevertheless a troubling minority of
bank officials who were violating the law. And I completely
agree with you. I think the aggressive use of law enforcement
made a real difference in terms of cleaning up banking and
savings and loan activity.
I think we are facing a similar situation here. There is a
minority, but still a troubling minority of people who are
abusing and violating the rules in order to achieve a short-
term economic gain for themselves and their companies. I think
by having swift and tough penalties, we are going to change the
way these corporate officials think and operate.
Senator Sessions. To follow up on that precise point, it
seems to me that many have argued that white collar criminals
are deterred just by the bankruptcies, by the short time in
jail, and all of those things. But to me, there is a moral
question here. If a person embezzles $50 million, or maybe
more, as some of these cases might suggest, their sentencing
range should not be a lot different than somebody who robs a
bank, in my view, if it is intentional fraud.
So I guess my question is are you in accord that we need to
enhance the penalties on these kinds of cases?
Mr. Chertoff. I don't think there is any doubt we do. The
amount of destruction that is caused by a person who commits a
white collar crime, like a fraud, can be every bit as serious
as the destruction caused by a burglar or somebody who commits
what we would normally consider not to be a white collar crime.
That is one of the reasons I think the President has called
for not only an enhancement of the penalties according to the
statute, but also for the Sentencing Commission to make sure
that we are adequately aggravating sentences to take account of
those who betray their corporate trust.
Senator Sessions. The way the Sentencing Guidelines are
focused, I believe, is a bit off center. Their focus is on the
extent of the loss, or in a drug crime almost exclusively on
the amount of the drugs, the weight of the drugs. But I have
always felt that the true measure of criminality and the
punishment is the degree of criminality, the degree of
malicious intent, the degree of conscious fraud that has
occurred.
Do you think we can do a better job of considering that
factor in the sentence that is imposed?
Mr. Chertoff. Well, the Guidelines do contemplate that one
can look to factors other than just the amount of the loss or
the amount of----
Senator Sessions. It is fairly limited.
Mr. Chertoff. There is no question the Commission could
consider the possibility of adding more weight to other
factors, such as the degree of violation of trust, irrespective
of the dollar loss. So I think there is a wide range of choices
that can be made by the Commission in terms of how to implement
a broader vision of what kind of penalties are appropriate in
white collar cases.
Mr. Mercer. I would like to add something to the Assistant
Attorney General's comments on that. I think one of the things
that we really face as U.S. Attorneys in trying to deal with
this is the fact that we have an increasing number of non-
substantial assistance downward departures.
Senator Sessions. By the court?
Mr. Mercer. By the court, upon a defendant's motion. In a
white collar case----
Senator Sessions. Do you consider those rulings in
violation of the Guidelines?
Mr. Mercer. The courts clearly have authority to do so
either as factors that are considered and have been
specifically incorporated within the Guidelines by the
Commission and/or by the Supreme Court's decision in 1996, in
Koon, where the Court said if a factor wasn't specifically
prohibited, then a court can consider that in terms of crafting
a sentence.
So it is rare for white collar sentencing to occur without
a defense lawyer saying there are extraordinary circumstances
based upon the community ties or the community service that the
defendant rendered prior to sentencing. Or maybe there has been
extraordinary post-offense rehabilitation, or maybe there are
family ties or circumstances.
We hear about these all the time when we are sentencing
criminal cases, and I think it really goes to Senator Durbin's
question. If you have a range that the Commission has
established that, in their view, appropriately deals with a
crime for courts then to enter downward departures--and we had
600 non-substantial assistance downward departures in the fraud
guideline in 2000 is troubling. There are a substantial number
of districts that have substantial numbers of non-substantial
assistance downward departures in fraud cases.
Senator Sessions. Were those on the recommendation of the
prosecutor or all on the judge's own decision?
Mr. Mercer. Well, that is based upon the judge's authority.
It is not a substantial assistance departure where----
Senator Sessions. No, but you could still agree to it. Do
you know if those have been over the objection of the
prosecutor, or do your numbers disclose that?
Mr. Mercer. The data set that I am looking at doesn't
disclose that. I can tell you that in U.S. Attorney Comey's
testimony before this committee, in his prepared remarks, we
summarized a number of court decisions where the Government had
taken affirmative appeals to object to non-substantial
assistance downward departures made by courts.
I think the committee can get a flavor of the Government's
concern in those cases. But as we said in that testimony, there
are a number of times based upon the Koon decision or based
upon where a factor isn't prohibited that we simply aren't
really able to pursue an appeal because it wouldn't be one that
would be reversed by the court of appeals.
Senator Sessions. I remember, Mr. Chairman, when I first
became United States Attorney before the Guidelines were
passed, which was the most significant change in the history of
law enforcement since the founding of this country.
Chairman Biden. Thank you very much.
Senator Sessions. And you deserve much credit for that. I
remember telling a Federal judge, in exasperation, when a
defendant had smuggled 15,000 pounds of marijuana, and the
Judge was thinking about giving a 5-year sentence, I said,
``Sir, we just had a presidential election. The President of
the United States put me here and the American people have
spoken on this.'' But the judge could give zero to 15 years,
totally unlimited, whatever he wanted to do.
I think the judges began to sense from the American people
that the judges cared more deeply about large drug smugglers
and sentences went up, and then the guidelines kept them up.
And I believe we are at this point now.
Chairman Biden. I agree.
Senator Sessions. I think it is perfectly appropriate for
Congress to affirm that we need to do a better job of that.
My time is up. Mr. Chertoff, I know you can use some
additional prosecutors, but there are a whole bunch of them out
there from the Savings and Loan days. I don't know what they
are doing. I don't know how many more new ones you need,
actually. It is just an emphasis. If it is clear that you
expect your team to give it high priority, I think you may have
enough people already, or close to it.
Chairman Biden. Thank you very much.
As we break for this vote, because we only have a few
minutes left, I would just like to point out the losses weren't
just the people at WorldCom who had pensions. It cost the State
of California retirement system over half a billion dollars;
$300 million, the State of New York pension fund; Michigan
pension fund, $116 million; Florida, between $85 and $100
million; Kentucky, $8 million; Wisconsin, $36.3 million; Iowa,
$33 million.
Senator Sessions. Alabama took a hit, too.
Chairman Biden. I assume my staff just picked the biggest
ones.
Do either of my colleagues have more questions for this
panel?
I do, but I am not going to ask you to wait because we are
going to be about 15 minutes, my guess is, and there may be
another vote immediately after this. So what we will do is I am
going to submit about six questions in writing for you, if I
could, General.
I would suggest to the next panel that if you have time,
you can go down and get a cup of coffee. I apologize. We don't
control the floor and it is going to take us somewhere between
10 and 25 minutes, depending on whether there is a second vote,
to get back here.
I thank the Justice Department for its cooperation and look
forward to your input specifically on the legislation, and I
also look forward to the questions you have.
[The prepared statement of Mr. Chertoff and Mr. Mercer
appears as a submission for the record.]
Chairman Biden. We will now recess until the call of the
Chair, which I expect to be about 15 to 20 minutes.
[The subcommittee stood in recess from 3:31 p.m. to 5:29
p.m.]
Chairman Biden. The hearing will come back to order,
please. We owe this incredible panel that we are so looking
forward to hearing a sincere apology and a debt of gratitude
for waiting. This is above and beyond the call.
You guys remember when you were in school the old joke was
you only had to wait 20 minutes for a full professor. You only
have to wait two minutes for a Senator, and you guys have
exceeded that by a couple of hours. Senator Sessions and I were
tied up. The irony of all ironies--and I won't take much more
time explaining--is that the very thing that we are talking
about on this panel literally got called up on the floor of the
Senate as we were waiting here. So I am truly sorry.
The next panel that we have, and our last panel, has some
very distinguished members. John Coffee is Professor of Law at
Columbia Law School, one of the great law schools in the
country. Before going to Columbia, Professor Coffee was a
lawyer at Cravath, Swain and Moore, where my more successful
colleagues at Syracuse went to work. He was a reporter for the
American Law Institute's Principles of Corporate Governance.
Professor Coffee is an expert on corporations, security
regulation, and white collar crime, and has published numerous
books and articles on these topics. We thank him for being here
today.
Second, we have Thomas Donaldson. He is Professor of Legal
Studies at the Wharton School at the University of
Pennsylvania. He was previously Professor of Business Ethics at
Georgetown University. He attended school at the University of
Kansas, where he majored in business, and got his Ph.D. in
philosophy also from the University of Kansas. The professor
has written four books on business ethics and more than 70
academic articles and book chapters. I welcome him as well.
Charles Elson is Professor of Corporate Governance and
Director of the Center for Corporate Governance at the
University of Delaware. Before that, he was Professor of Law at
Stetson University, a university my colleague and I know well,
and an attorney at Sullivan and Cromwell.
Professor Elson is an expert on corporations, security
regulation, and corporate governance. He has written on these
issues extensively and is the Vice President of the American
Bar Association's Business Law Section Center on Corporate
Governance. I want to thank him for making the trip down, and
maybe we will be on the same trip home. Columbia and Penn,
where my son went to school, are good, but Delaware is better.
That is my alma mater.
George Terwilliger is a partner at the law firm of White
and Case, where he leads their corporate defense and special
litigation group. Before that, he served as a Federal
prosecutor for over 10 years, and later as the Deputy Attorney
General in the first Bush administration. Mr. Terwilliger
earned his B.A. from Seton Hall University and his J.D. from
the Antioch School of Law. I want to thank him for coming as
well.
Tom Devine is the Legal Director of the Government
Accountability Project, a non-partisan, non-profit interest
group that works to protect the rights of whistleblowers. Mr.
Devine has been working at the Government Accountability
Project for more than 20 years and has been a resource for this
committee on more than one occasion. He has also taught and
written about whistleblower protection issues. Mr. Devine is a
graduate of Georgetown University and Antioch Law School, and I
want to thank him as well for joining us.
Gentlemen, I will not take any further time, and unless you
all have worked out something different, if you could deliver
your testimony in the order in which you were called. Usually,
we have a rule on time. There is no rule. You all take as much
time as you want. Again, I thank you very, very much for
waiting for me.
STATEMENT OF JOHN C. COFFEE, JR., ADOLF A. BERLE PROFESSOR OF
LAW, COLUMBIA UNIVERSITY SCHOOL OF LAW, NEW YORK, NEW YORK
Mr. Coffee. Senator, thank you for having me here, and let
me start out with the statement that I really have two areas of
specialization--securities law and corporate governance, on one
hand, and white collar crime and sentencing on the other. For
the last year, these two fields have merged.
Now, we are talking about a series of scandals and issues
that have broad macroeconomic impact. Absolutely every topic is
relevant, but I am going to be very narrow. I am going to talk
about the criminal law because I am someone who teaches the
criminal law regularly and I want to explore with you the
various levers that I think could be better used to maximize
deterrence in the area of white collar crime.
My initial message has already been stolen by Senator
Sessions, because he said he had some problems earlier with the
way in which the Sentencing Guidelines manual looks at fraud,
embezzlement, and similar types of offenses. I think that
particular guideline is a little out of date. It has got at its
core a kind of a concept that says securities fraud--we know
what that is; that is the Ponzi scheme in which the promoter
sells stock to the investors, and we will just look at the
amount of sales he made to those investors.
That is not what is going on in an Enron or WorldCom or
anything like that. We are dealing with cases in which the
books have been cooked. There are serious accounting
irregularities and the loss is not simply the loss to the
individual investors, because frankly the company may be
selling no stock during this period. The loss is really the
broader social loss of investor confidence in the system being
eroded.
When that happens, it is not just that stocks everywhere
decline, not only at Enron but a perfectly legitimate company
like General Electric will have a transparency discount, but
the broader loss is that when investor skepticism grows and
they lose confidence in the reported financial numbers, the
cost of capital for American corporations rises. And when the
cost of capital rises, that means interest rates go up,
economic growth is retarded, and layoffs become inevitable.
In that light, I think we should recognize that senior
corporate management involved in and convicted of securities
fraud, particularly securities fraud involving the credibility
of financial statements, is creating a social loss far greater
than the loss borne by individual investors, however computed.
Now, having said all that, I wrote this before I saw
today's Biden bill, which does instruct the Sentencing
Commission to develop a new guideline, and I would certainly
endorse that. I read the Leahy bill, but I had not read your
amendment to it, and I think that is something that should be
done.
I think that it should focus on criteria such as was there
an earnings statement, how many quarters were affected by this,
what level of management was affected, et cetera. I think there
should be an express recognition that when there is a person
with a very high-ranking fiduciary duty--the chief executive
officer--it is a more serious offense by that person than by
someone two levels down the totem pole who may be under
pressure from the top.
All of that, though, is something I think the Sentencing
Commission can address. I once served as the American Bar
Association's reporter on sentencing alternatives.
Chairman Biden. I remember that.
Mr. Coffee. I would urge you to go the Sentencing
Commission guideline route rather than adopting mandatory
minimums. There is always some over-breadth in mandatory
minimums.
Now, what else can be done under the Sentencing Guideline
route? We have heard a great deal of interest expressed,
including by the President yesterday, in recapturing, let's
call it the unjust profits that a chief executive receives when
he got stock options, bonus compensation, during a period in
which the company's stock price was inflated. The board of
directors may have believed that he was doing a great job. Only
later do you learn that all those numbers were fabricated.
There is a concept in sentencing that I think needs to be
given greater attention. It is not just the area of fines, it
is the area of forfeiture and disgorgement. American sentencing
law says that if you catch a person with ill-gotten gains, he
forfeits that. In other words, if I am a bank robber and I am
caught robbing a bank with $1 million in my hand, I am not
fined $1 million. I just forfeit it because it wasn't properly
mine.
I think when we look at the area of executives who have
received stock options or seen those stock options inflate
during the period in which corporate financial statements were
seriously and materially false, it is possible to deem that a
form of unjust ill-gotten gain that could be captured
underneath the disgorgement sanction.
Now, I am not saying that Congress should say this itself.
I think the Congress should rather instruct the Sentencing
Commission to develop the concept of forfeiture and
disgorgement, as it might be used as an additional sentencing
sanction, in addition to criminal sentences and fines, as a way
of having one expedited proceeding in which they would forfeit,
if convicted of a crime, the ill-gotten gains, which could
include bonus compensation, stock option appreciation, or the
award of stock options.
Again, there is a need for detailed and nuanced guidelines,
but I think that is an additional area which we would have one
proceeding that would efficiently take away all the gain,
rather than talking about having the SEC or a private plaintiff
sue them.
Chairman Biden. Professor, can I ask for a clarification on
that?
Mr. Coffee. Certainly.
Chairman Biden. I am the guy that drafted the forfeiture
legislation relating to drug cases. So when we use the word
``forfeiture''--I understand it in a literal sense, but it is
used up here and anyone reading your testimony will assume that
we mean that if you can prove that the ill-gotten gains were $5
million and you could not find the cash, you can go take his
house. You can take his car, you can take his yacht, et cetera.
Is that what you mean when you use the word ``forfeiture?''
Mr. Coffee. That is one way of doing it. It is also
possible to use simply the common law approach which the
Guidelines could codify that if you had the proceeds of a crime
in front of you in a court, that gets automatically forfeited.
Chairman Biden. But if you don't have the proceeds of the
crime in front of you in court--in other words, he has cashed
out the stock options.
Mr. Coffee. Money is fungible. I think you could trace the
money.
Chairman Biden. Yes, okay. I just want to make sure we are
talking about the same principle.
Mr. Coffee. Well, I think you give some authority saying we
want to have the concept of forfeiture apply to these ill-
gotten gains, and instruct the Commission to come up with a
more----
Chairman Biden. As opposed to drafting legislation?
Mr. Coffee. As opposed to simply either writing a one-
sentence statute that won't deal with all the problems, or as
opposed to instead telling the SEC to sue or telling private
plaintiffs that they can sue, all of which will take five more
years and involve two or three more judges.
Chairman Biden. I am with you. I just wanted to make sure I
understood it. Thank you very much.
Mr. Coffee. Now, additional things I think you should focus
on: There will also be occasions in which the corporation will
be prosecuted. That may or may not happen in Enron because it
is bankrupt, but securities fraud is an offense----
Chairman Biden. It happened at Andersen.
Mr. Coffee. Okay. It certainly is a case in which we would
like to see corporations occasionally prosecuted. I won't get
into the nuances of when yes and when no. When we do that--and
I was one of the draftsmen of these provisions back in 1991--we
have very elaborate organizational guidelines which put very
significant weight on whether or not the corporation has an
effective compliance plan.
There are seven elaborate criteria set forth in the
Sentencing Guidelines manual to determine when you do have an
effective guideline compliance plan which can reduce the
sentence by 50 percent or more. We have had those guidelines
for a decade now and I don't think anyone has a clear idea of
whether or not those guidelines have any deterrent value,
whether they are producing compliance plans that do reduce the
risk of corporate crime, that do create greater internal
monitoring.
I think there is some possibility that those compliance
plans were all adopted by one or two law firms coming up with a
standard form compliance plan that is used by 500 corporations,
with very little attention.
I think two things. There should be a study about whether
those compliance plans do create enough value to justify the
enormous sentencing credit that they create. There is lots of
theory here, but very little observation.
Secondly, I think we can easily redesign these guideline
compliance plans so as to create a number of desirable
consequences, including much greater protection for
whistleblowers. I certainly understand that the Leahy bill
gives protection to whistleblowers against retaliation, but
that comes when we are talking about the criminal law at the
later stages.
If a company wants to have an effective compliance plan, it
would be possible to address in it and require as a minimum
condition that these compliance plans had to establish a
variety of techniques, whether they are anonymous hotlines,
whether they are direct connections to the audit committee.
I don't want to get into the details of specifying what
should be the adequate procedures to invite anonymous and
confidential comments from employees who feel that this conduct
is occurring, and I don't want to get into the details of who
they should report to, whether it goes to the audit committee
directly or someone else.
But I think we can take best practices as they now exist
and incorporate them into our standard of what a compliance
plan should look like, because a compliance plan is ultimately
an invitation to the company to do something in advance to get
an enormous credit in the event that you are ever convicted. I
think that is an area where you can take best practices, not
make them mandatory, but say if you want enormous sentencing
credit, you should be complying with the best practices in the
area of both compliance plans and treatment of the potential
whistleblower.
A last point, because I realize I am running long on time.
We have another sanction that is available but little used. It
is corporate probation. Now, it can be used in addition to a
sentence when we convict the corporation. When we have that
kind of world in which the corporation appears to have been
somewhat dysfunctional and there were corporate governance
failures, we will often find that there are corporate officers,
past or present, who may have deceived the company, received
ill-gotten gains, elaborate loans in some recent examples, and
we have a problem.
The corporation may have great difficulty asserting claims
against those individuals because the corporation has its own
internal conflicts. There may be a controlling shareholder,
there may be other problems on the board of directors.
One way to resolve that is to authorize as a condition of
probation that the court appoint a court-appointed monitor,
which monitor would have the corporation's power to assert
claims against past and present officers and directors who may
have engaged in improper self-dealing.
What I am suggesting is that as part of the sentencing
process, the court could appoint a basic equivalent to the
special counsel that we all know about from the public sector.
The public sector has special counsels occasionally
investigating Cabinet members and the like. If we have
pathology in a corporation and the corporation has been
convicted of a crime and there is some evidence that
individuals may have wronged the corporation, appointing such a
court-appointed monitor, with authority in the name of the
corporation to sue for a recovery to the corporation, creates
an efficient and fairer and more independent procedure than
either relying on a board of directors that might be
compromised in some cases or relying on the tender mercies of
the plaintiff's bar, which often gets a larger fee than they
get a recovery in the world of derivative actions.
So I suggest there are ways that the concept of corporate
probation could be utilized to try to rectify corporate
governance problems that emerge in these corporate accounting
irregularity cases, and in particular that they can be used as
a way to ensure that individuals don't escape with their unjust
gains.
Thank you.
[The prepared statement of Mr. Coffee appears as a
submission for the record.]
Chairman Biden. Thank you very much, Professor.
Professor Donaldson, thank you for being here today.
STATEMENT OF THOMAS DONALDSON, MARK O. WINKELMAN PROFESSOR, THE
WHARTON SCHOOL, UNIVERSITY OF PENNSYLVANIA, PHILADELPHIA,
PENNSYLVANIA
Mr. Donaldson. I speak not as an expert in law, but in
business ethics, and I am reminded of the fact that over 200
years ago Adam Smith, the father of capitalist, himself a
professor of ethical philosophy, said something that agrees
well with what Amartya Sen, the recent Nobel Prize Winner in
Economics, said, namely this remarkable system of capitalism--
even this remarkable system doesn't function well unless it can
rely on the integrity of its participants.
There are a number of economic duties of citizenship that
are required in order for capitalism to function well. Some of
these are engaging in fair competition, not abusing government
relationships, providing non-deceptive information to the
market. Recent scandals have turned heavily on this last issue.
When companies fail to provide investors with accurate
information, investors make worse decisions, and in turn
efficiency lowers.
However, one characteristic winds its way throughout all of
these duties of economic citizenship, and it is that for
markets to function well, at least a critical mass of people,
and in particular executives and managers, must behave much of
the time for reasons that assign intrinsic worth to certain
values; that is to say, we have to have a threshold mass of
people who are willing to do something because it is the right
thing to do and not because they will avoid legal penalties,
and not even because they will avoid financial losses.
The limits of the law and regulation to cope with corporate
ethics became obvious in the last century as we learned, for
example, that information inside an industry often races ahead
of the knowledge outside of it, including the knowledge of
regulators. Industries like asbestos became very difficult for
regulators and the government to regulate effectively because
knowledge inside the industry typically led knowledge outside
the industry. In recent scandals, it was often a new, clever
scheme, a financial arrangement such as the raptors at Enron
that bedazzled and cheated investors. By the time the law and
the investor had caught up, it was too late.
None of this is to say that we don't need new and tougher
laws. In fact, we do, and I support very much what I have seen
coming out of this committee and indeed what is being proposed
today in the Senate, but it is to clarify the contours of a
broad solution to our current mess.
Unfortunately, many of the most popular attempts to improve
corporate ethics have been either lukewarm successes or
failures. My colleague, Professor Coffee, alluded to one of
them, namely the compliance systems that have arisen in the
wake of the corporate criminal sentencing guidelines.
Ethics and compliance programs abound now; they are hot. In
1991, I don't have to tell you the U.S. Sentencing Guidelines
offered companies a dramatic incentive to develop formal
programs. The Guidelines promised reduced penalties in exchange
for bona fide ethics and compliance programs.
Unfortunately, no persuasive data exists suggesting a
correlation between having such a compliance program or an
ethics code and lessened pressure on executives to commit
unethical acts. In fact, some of what was being suggested here
has already been attempted.
My colleague, Bill Laufer, at Wharton has done a study of
the efficacy of the corporate criminal sentencing guidelines
and the results have not been encouraging. Now, I don't think
this is because codes and compliance----
Chairman Biden. Has that study been done and published?
Mr. Donaldson. Yes, Bill's study has been published and I
will be happy to make it available to you.
Chairman Biden. Great. I would like to see it. I am just
unaware of it and I would like to see it.
Mr. Donaldson. By the way, let me hasten to add I am not
suggesting that codes and compliance programs are worthless. In
fact, I think, when well designed, they are very important.
That is not my point. In fact, discovering whether they are
effective or not, I think, is an almost insurmountable
technical research task.
But one thing is clear from this. Codes and compliance
programs are, at best, only the first steps in successfully
managing corporate ethics. We would do well to remember the
dazzling creativity of corporate slime. In the recent spate of
Enron and WorldCom tragedies, every time it has been a new
scam.
Enron, for example, had all the bells and whistles of a
modern compliance program. Employees had wallet cards. Almost
all of them could repeat the word, RICE, Respect, Integrity,
Communication, Excellence. And they had the usual thick list of
rules that was passed around and signed every year. None of
this came close to preventing the Enron implosion, nor are such
mechanisms relevant for virtually any of the recent scandals.
The most important determinants of ethical behavior in a
corporation are the way managers are rewarded, the culture of
the corporation, the leadership example that is set, and the
institutional systems surrounding the corporation, including
legal and regulatory systems.
Hence, it is a mistake to think that our current problems
are simply the product of a few bad apples. Corporate
Watergates typically involve scores, and sometimes hundreds of
people inside the corporation, and often many people outside
the corporation in institutions such as accounting firms,
investment banks, and law firms.
I believe the single most important change fueling the
recent corporate scandals is the transformation of the
compensation system for upper-level executives. We have moved
from a cash-based system to a stock-based one. Good reasons
exist for the change, but we must now see that the game of
executive motivation has forever changed.
Over the past two decades, I have talked with hundreds of
executives about issues they have confronted in ethics behind
closed doors. During the last six years, the tone of those
conversations has shifted markedly. Increasingly, short-term
stock price has assumed significance as the salient goal, and
increasingly these executives' ethical pressures center on
either the demands they must make or the demands they must
fulfill to bolster short-term stock price. That is one of the
reasons I very much agree with Senator Biden's suggestion that
we need to get at the incentive system that surrounds
executives in the corporate suite.
What should we do? We need more laws of the kind that are
being considered today. We need better enforcement and more
resources, and we need to arrange the incentives in the
executive suite. But we also need to educate Americans, and
especially current and future executives, about the importance
of ethics.
Part of this duty falls on you, elected representatives,
but a lot of it falls on me and my colleagues, especially at
business schools. These schools, the training grounds for
tomorrow's executives, have the unavoidable duty of taking
ethics seriously wherever it arises, in accounting, in
marketing, in management, and in finance.
Thank you.
[The prepared statement of Mr. Donaldson appears as a
submission for the record.]
Chairman Biden. Thank you very much, Professor.
Professor Elson?
STATEMENT OF CHARLES M. ELSON, EDGAR S. WOOLARD, JR. PROFESSOR
OF CORPORATE GOVERNANCE, AND DIRECTOR, CENTER FOR CORPORATE
GOVERNANCE, UNIVERSITY OF DELAWARE, NEWARK, DELAWARE
Mr. Elson. I come to you all as a professor of corporate
governance, but I used to be a law professor in my old life, so
a little law will leach its way into my testimony.
Chairman Biden. That is okay.
Mr. Elson. Good for the soul.
When I taught law, the fundamental point to law students
vis-a-vis civil and criminal sanctions was that criminal
sanctions were designed to punish and deter. That was the whole
point. White collar criminal prosecution has the exact same
goal, to punish wrongdoers and deter bad conduct going forward.
How does this apply in the corporate context?
I believe very strongly in criminal prosecution and
punishment for those who intentionally act in a self-enriching
fraudulent manner, in violation of the securities and other
financial regulatory law. I think it is good deterrent policy.
Criminally prosecuting folks who break the law intentionally
deters bad conduct going forward.
I think an example of this is in the area of insider
trading regulation. Initially, insider trading was prosecuted
civilly. It didn't work, and by the mid-1980s we engaged in a
number of criminal insider trading prosecutions, very high-
profile, and I think they achieved the proper deterrent impact.
Obviously, in the corporate fraud area the same thing
applies. I think that the solution is to enforce the laws on
the books and commit more funds to enforcement. It is good
deterrence. If someone aggressively, actively, knowingly
violates the law, they should be punished.
Now, I think it is important to create a distinction,
though. It is fine to punish self-dealing, or, in the
vernacular, sleazy conduct and those who conduct that sleazy
conduct criminally, perfectly okay. The problem, though, is
when you begin to change the standard a little bit and
prosecute what is, in essence, slothy or sloppy conduct in the
corporate context criminally.
I think what then happens, unfortunately, is it creates the
wrong incentives, in that it will result--and this comes out of
what was referred to earlier, the Federal sentencing guideline
corporate compliance code, or as we say in the State law
context the Caremark codes, which results, I think, in numerous
procedures that are adopted by companies to prevent legal
liability that end up elevating form over substance, and in the
end I think create activity that is harmful to shareholder
interests because people are more interested in meeting the
legal requirements than actually thinking through what was the
intent of those legal requirements--form over substance, if you
will.
I think when you prosecute someone criminally for slothy or
sloppy conduct, it creates a desire on the part of those slothy
individuals to avoid potential liability and it creates systems
within the corporate organization that, in fact, are form over
substance. I think that is what happened, unfortunately, in the
Sentencing Guidelines and the Caremark case.
The solution to slothy conduct is internal. It is creating
vigilant, independent, equity-compensated, equity-holding
boards of directors. I think that that in the end creates the
greatest incentive within the organization to act carefully.
On the other hand, self-dealing conduct can't be dealt with
in that manner and it has got to be dealt with through the
criminal process, because I think as we saw in the insider
trading area, it was the only effective method, in my view, of
deterring future bad conduct.
Chairman Biden. Thank you very much, Professor.
Mr. Terwilliger?
STATEMENT OF GEORGE J. TERWILLIGER, III, WHITE AND CASE, LLP,
WASHINGTON, D.C.
Mr. Terwilliger. Thank you, Mr. Chairman, Senator Sessions.
As you noted, I was a Federal prosecutor for 15 years. Today, I
am in private practice at an international firm and I regularly
represent corporations and other institutions involved in
Government investigations, enforcement proceedings, and
sometimes prosecutions.
Senator Sessions. Do you think he has gone soft now that he
has been representing those big corporations?
Chairman Biden. No, no.
Senator Sessions. Maybe we will get an objective analysis,
having been on both sides.
Mr. Terwilliger. I hope so, Senator.
I do have the privilege of helping clients today understand
and navigate the business enforcement issues, but I also
cherished my role as an Assistant U.S. Attorney, as a colleague
of yours, Senator Sessions, as a United States Attorney, and as
Deputy Attorney General.
I vigorously prosecuted white collar crime cases, including
the BCCI matter which involved the prosecution of a
corporation. While I was U.S. Attorney in Vermont, I tried a
case against two local bank presidents, one of whom was very
popular. They abused positions of trust and went to jail.
I accepted your kind invitation to be here today and stuck
around, Senator Biden, because----
Chairman Biden. I do appreciate it, I really do.
Mr. Terwilliger. Well, I am happy to be here because I
believe it is essential that this loss of faith that we are
talking about in business be remedied, but I also fear that we
are in danger of overreacting in how we respond.
The crisis we have is to one of the most fundamental
prerequisites to our economic well-being--investor confidence
in the capital markets. Without that kind of confidence, our
economic engine is starved for fuel. But because the matter of
confidence in financial reporting is so fundamental and
sensitive, steps taken to address it, in my judgment, should be
carefully considered and measured.
Most business leaders today are, in fact, honest, law-
abiding, and faithful to their duties to secure the interests
of stockholders. Many may indeed be aggressive, and in most
cases rightly so. A few are crooks. Now, however, the many bear
the burdens created by those few.
Financial accounting and reporting is not an exact science.
Experts can, and do, disagree about how accounting items should
be treated. These disagreements and uncertainties, though, are
different than the intentional exploitation of fuzzy lines to
perpetrate a fraud.
In the context of financial reporting, a fraud means that
investors and regulators are intentionally deceived about a
company's performance, not simply that experts disagree about
how that performance should be accounted for and reported.
Truly corrupt business practices, of course, deserve
sanctions, but I believe we need to be very careful about whom,
and more importantly what we sanction. Corporations and other
business entities provide the jobs that give Americans an
unparalleled standard of living and fuel the crucial consumer
sector of our economy.
Individuals who engage in intentionally corrupt financial
practices or reporting betray their duty to the entity that
employs them, their responsibilities to shareholders, and their
obligations under the law. But unlike these real persons,
corporations and other business entities cannot think or act
for themselves.
Thus, while individuals can, and do, form the corrupt
intent that defines criminal behavior, to ascribe criminal
intent to a corporation is a judicially-created legal fiction
endorsed by the Supreme Court in 1909. Even though legally
permissible, sanctioning a corporation for a crime may be less
effective than some alternatives in influencing positive
corporate behavior.
I honestly believe, and candidly say so, that neither new
crimes nor increased penalties alone are going to solve our
problems. In fact, we might remember that in the real world
excessive exposure to draconian sanctions in economic crime
cases has the potential to discourage meaningful corporate
critical self-examination, as well as disclosure, cooperation,
and guilty pleas by individuals and companies. In addition, as
initiatives are considered, reviewing relevant and fundamental
precepts of our constitutional system can provide some
invaluable guidance.
It is, for example, helpful to recall that a core function
of the Federal establishment is to promote and secure the
benefits of commerce to the people. In harmony with this
purpose, for over 200 years the Federal criminal law applicable
to commercial activity was aimed at protecting the means and
instrumentalities of commerce.
Surely, capital and credit markets are obviously key means
and instrumentalities of commerce, and protecting them from
corrupt practices is consistent with this core Federal role.
The question, though, is how best to do that, and it seems to
me that the answer is not to reflexively create new offenses or
simply impose greater sanctions. Rather, it may be more
efficacious to seek a balance, including incentives for good
corporate practices, correction and reform of questionable
practices, and reserving effective sanctions, and severe ones,
for truly corrupt practices.
There are alternatives to corporate criminal prosecutions
that can help restore confidence in our companies and our
financial systems. First and foremost, as the President
recognized yesterday, corporations themselves need to do more
to promote confidence in their own performance and in their
financial reporting.
Steps include more active internal oversight, including
through board audit committees. Internal auditors and audit
committees can be highly effective inside watchdogs. It is
better to have financial reporting that gets it right the first
time.
Likewise, corporate legal officers and auditors should not
merely empowered, but encouraged and provided the resources to
proactively investigate internal malfeasance. This is not only
good public policy, but has significant value in protecting
corporations.
The Government can do much to encourage critical self-
examination by corporations and other business entities. Real
incentives rather than just rhetorical ones should attach to
voluntary correction and disclosure of wrongdoing. I must
report to you that most attorneys advising companies today are
forced to conclude that the benefits of voluntary disclosure
are insufficient to outweigh the risks attendant to them.
As an example, even a limited waiver of attorney-client
privilege requested by prosecutors can result in a complete
loss of privilege in related civil proceedings by private
parties. Congress could consider a statute making limited
waiver agreements with enforcement authorities enforceable
against third parties. Although this may sound radical,
particularly at this point in time, as a matter of
prosecutorial policy business entities that make timely
disclosure of wrongdoing might enjoy a presumption, not a bar,
but a presumption against criminal prosecution.
I do not advocate going lightly on real cheats and crooks.
A dishonest market is not a free one. But we must also work to
discriminate between conduct that merits the harshest sanctions
and that which can be addressed more effectively through
alternate means.
Because facilitating commerce is a core Federal
responsibility, we should police the marketplace, in my
judgment, judiciously, utilizing good judgment and discretion
in establishing and assessing sanctions for commercial
misconduct.
Mr. Chairman, I would ask to submit the balance of my
statement for the record, if I may, and thank you very much for
having me.
Chairman Biden. Without objection, it will be. Thank you
for being here.
[The prepared statement of Mr. Terwilliger appears as a
submission for the record.]
Chairman Biden. Mr. Devine?
STATEMENT OF TOM DEVINE, LEGAL DIRECTOR, GOVERNMENT
ACCOUNTABILITY PROJECT, WASHINGTON, D.C.
Mr. Devine. Thank you for inviting my testimony.
It is rare for the Government Accountability Project, but
my primary goal this evening is to offer credit where it is
due. Through the provisions creating state-of-the-art
whistleblower protection that were unanimously approved by this
committee and on the Senate floor this afternoon, the Judiciary
Committee exercised bipartisan leadership for a genuine
breakthrough in corporate accountability.
The Corporate Fraud and Accountability Act of 2002 is
outstanding, good-government legislation. It complements your
leadership in today's hearing. The Act's centerpiece is legal
rights for whistleblowers at publicly-traded corporations.
Future Sherron Watkinses could not be fired at will for warning
corporate leaders or shareholders of consequences from
cheating, such as bankruptcy liability or other risks that
could sabotage investments.
The strategy is creating a safe channel for shareholders'
and management's right to know, as well as for testimony in law
enforcement investigations. The goal is to frustrate cover-ups
by giving reprisal victims access to district court jury trials
if they cannot receive a timely decision from what all too
frequently has been the black hole of the Department of Labor's
administrative law system. For example, our organization has
represented a client with a case pending there for 14 years.
The cases would be governed by the modern legal burdens of
proof that Senator Grassley helped create in the Whistleblower
Protection Act of 1989 for Government workers.
Disclosure has been the trans-ideological, bipartisan
cornerstone of all post-Enron reform proposals. The common-
sense logic is unassailable. Two long-accepted truths are,
first, that secrecy is the breeding ground for bureaucratic
corruption, and, second, that sunlight is the best
disinfectant. Otherwise, even the best corporate leaders are
ignorant of misdeeds until they are being blamed for the
consequences. Similarly, shareholders are blind-sided by risks
being taken behind their backs. The ultimate fate of the
Judiciary Committee's whistleblower legislation will confirm
whether political leaders are serious about disclosure.
Whistleblowers are the Achilles heel of bureaucratic
corruption. As the eyewitnesses to the birth of scandals, they
are indispensable to bridge the secrecy gap. Their free speech
right is more than just the freedom to protest misconduct. It
also includes the freedom to warn.
In the Netherlands, for example, these individuals are
called bell-ringers, after folks who climbed the church tower
to warn the community of danger. In other nations, they are
called lighthouse-keepers, after those who shine the light on
rocks which could sink ships arriving in their harbors or
ports.
The common theme is warning about threats to the public's
well-being before avoidable crimes or disasters occur and
before we are limited to damage control. Over and over, their
dormant potential has been proven anecdotally since the 1980s.
The common theme in the disclosures of whistleblowers
represented by the Government Accountability Project has been
warning of liability or Government sanctions for cheating.
Sherron Watkins acted as a corporate Paul Revere by warning
that devastating liability was coming. Enron chief Ken Lay
ignored her at his own peril and sealed his doom. These people
are the lifeblood of anti-corruption campaigns, which are
lifeless, empty symbols doomed to failure without testimony
from those who bear witness. It is just a truism to share with
some of the folks I am talking within this audience that it can
be very difficult to win criminal convictions without leads and
testimony.
Whistleblowing disclosures to the SEC doubled during the
Enron hearings, and the SEC enforcement chief commented,
``Because of this phenomenon, we are learning of potential
securities law violations earlier than ever before. Keep those
cards and letters, not to mention e-mails, coming.''
But unless rights are locked in, things will soon be back
to normal and would-be whistleblowers will decide instead to
stay silent observers. Ironically, except for Senator
Grassley's work on the False Claims Act, the norm is that
whistleblowers proceed at their own risk when sounding the
alarm.
Corporate law is a crazy quilt of hit, or usually miss,
protections for everything except the False Claims Act. With
scattered exceptions, the lucky ones who have coverage are
prisoners of the Department of Labor's administrative law
system, and the norm there is well over two years to get a
decision, with no chance for interim relief. That is
professionally akin to patients who die while they are waiting
for the operation to occur, while they are waiting for an organ
donor or something like that. Ms. Watkins only survived because
Enron collapsed before retaliation could be carried out, and
then she became a celebrity. For whistleblowers, the sad truth
is that if you are not a celebrity, you are cooked.
As Professor Fred Alford of the University of Maryland
observed, for every Sherron Watkins there are several hundred
whistleblowers who lack the protection of visibility. These
people are openly fired for disloyalty to company managers who
themselves often were breaching their fiduciary duty to the
shareholders. It really raises the question, loyalty to whom?
Initially, this reform appeared trapped by a partisan
deadlock, but thanks to work beyond the call of duty by
Senators Leahy and Grassley's staff, we achieved a composite
model that sparked a consensus. The Judiciary Committee's
compromise is a win-win for everyone, except corporate crooks.
Honest managers, boards, shareholders, whistleblowers, and
Federal law enforcement agencies will be empowered with an
early-warning system to prevent new Enron disasters by nipping
scandals in the bud. It would place the United States in
compliance with the whistleblower requirement in international
anti-corruption treaties.
The unanimous committee approval in today's vote suggests
the Senate may be ready to prove it is serious about making a
difference, and that is a welcome development. Legislators of
both parties have rhetorically lionized whistleblowers and
chastised those who violated their duty by remaining silent,
but it is time to add genuine rights to this rhetoric. The
rhetoric rings hollow to someone who is fired and facing
bankruptcy for warning a corporation of that same risk.
The legislation adopted by this committee should be a
beachhead for other stalled pending legislation, especially S.
995, amendments to revive the Federal Whistleblower Protection
Act, which was the strongest free speech law in history when
unanimously approved by Congress in 1989 and strengthened in
1994.
But after brazenly hostile activism by a court with a
monopoly on judicial review, it is a trap that creates more
victims than it helps, and our organization, which worked to
pass that law, has to warn people against using it. There is
also legislation to provide whistleblower rights for FBI
employees, also approved by this committee, and Federal baggage
screeners, introduced by Senators Grassley and Levin, which
would close inexcusable loopholes. These bills badly need
bipartisan sponsors, and I hope there will be an opportunity to
work with your staffs on this legislation.
The Judiciary Committee bill is only a first step, but it
is a giant step forward. It means that future Sherron Watkinses
will have rights when they risk their personal financial future
to defend that of the shareholders. It is unrealistic to expect
that whistleblowers will defend shareholders or the public if
they can't defend themselves. Like current corporate
whistleblower law, profiles in courage are the exception, not
the rule.
Thank you.
[The prepared statement of Mr. Devine appears as a
submission for the record.]
Chairman Biden. Thank you very much, all of you. The
Senator and I are used to working together, and since there is
the two of us, we are just going to sort of have a conversation
with you, okay?
Mr. Coffee. Senator, I have to leave in about ten minutes
to make my airplane, which is the last plane of the night going
back to Newark.
Chairman Biden. We will have a conversation with you first,
if we can.
Let me say sort of as a context for the few questions I
have that I want to make it clear that I, for one, do not
believe that merely changing criminal penalties and sanctions
is going to solve this problem. I do agree with you, Mr.
Terwilliger, that the loss of faith we are experiencing now may
produce overreaction.
I have been involved either directly or indirectly or
literally writing every major criminal law, for good or bad--I
made some big mistakes, like the crack cocaine question--since
1984.
Mr. Terwilliger. Mr. Chairman, if I may, I don't mean to
interrupt you, but I know you have, having worked directly with
you when I was Deputy Attorney General. You have been a member
of this body that has certainly put no partisan interest in the
way of very truly substantive work for the benefit of the
criminal law.
Chairman Biden. Well, I thank you.
Let me tell you I am worried in this moment that we find
ourselves, and the extent of the anger that is palpable. As you
all know better than I do, more people are, quote, ``in the
market'' now, average people. It is amazing.
I commute everyday. The conductors come up to me. These
guys are blue-collar workers, my buddies, and they are in the
market. I mean, their 401(k)s are in the market, but they
personally are dealing on their computers; they are day-
trading. I don't know the number, but I think----
Mr. Coffee. I know the number. Eighty-eight million
Americans directly own stocks or mutual funds.
Chairman Biden. Is that a higher percentage than in the
1920s?
Mr. Coffee. About 50 percent of American households have a
stock investment. In Europe, it would range between 15 percent
and 12 percent, so we are three times more invested than any
maximum in a European country.
Senator Sessions. Mr. Chairman, Professor Coffee has to go
in just a minute. I had one question.
Chairman Biden. Go ahead, if you have a question for him
directly.
Senator Sessions. My question was when you talk about a
special counsel, would that be something like what happens in
bankruptcy where a trustee comes in, but this company may not
be in bankruptcy?
Mr. Coffee. It could be very similar to that because the
trustee takes over the board's powers
Senator Sessions. They would sue the officers to recover
assets for the company?
Mr. Coffee. I don't want to supplant the board of directors
generally. They should still be the decisionmaking organ. But
with regard to the decision, do we sue the former chief
executive who was our friend and colleague, do we sue the
controlling shareholder who has a lot of friends on the board--
that is the world where in the appropriate case the probation
condition could be one under which the court appoints an
officer who will make a disinterested decision and who will not
be motivated, as plaintiffs' attorneys sometimes are, by the
prospect of a one-third recovery. It will be more of a fair,
independent decision.
Chairman Biden. Well, let me speak to that for a second.
What is the problem with motivating an attorney? I mean, I find
this kind of interesting. Part of our English jurisprudential
system for 800 years has been, before Adam Smith and since Adam
Smith, that if, in fact, you do not want government to grow and
government to--and I will put this in the most base terms I
can--and if you cannot have or do not successfully have self-
effectuating mechanisms that the industry places upon itself or
individuals do, then we basically have said as a part of our
capitalist system that what we will do is we will incentivize
people to allow stockholders and allow investors to, in fact,
stop bad behavior that occurs, whether or not they can recover
everything that they want to recover.
To put it in its most naked terms, thank God for vultures;
they clean up the roadkill. Let's assume that every plaintiff's
attorney, which seems to be what is the view in this town the
last ten years, is a vulture. I disagree fundamentally with
that, but let's assume they are.
Mr. Coffee. I am not disagreeing with that, Senator. In
fact, I was the special counsel to the White House general
counsel office during the passage of the PSLRA, and I do agree
that there is a role.
The special problem about derivative actions is that unlike
the class action, where it tends to be a kind of joint venture
in which the legal entrepreneur gets 25 to 30 percent if the
recovery, in a derivative action very often the plaintiff's
attorney is able to settle on a cosmetic basis and, in effect,
preempt the entire recovery. You get a settlement for cosmetic
relief and you get a several-million-dollar award in attorney's
fees, and I think that does not serve well the shareholders.
Chairman Biden. Now, let me speak to that one way and then
let you go, because I am told you must leave very soon. If the
issue is that that action, the derivative action,
overcompensates the attorney and under-refunds, if you will,
the stockholder, that wouldn't even matter to me if, in fact,
it affected corporate behavior.
Are you suggesting that it doesn't affect corporate
behavior?
Mr. Coffee. I really have two points here.
Chairman Biden. I am not disagreeing. I am trying to
understand you.
Mr. Coffee. I served for 13 years as the reporter to the
American Law Institute for its Litigation Remedies Section as
part of the restatement of corporate governance.
Chairman Biden. Right.
Mr. Coffee. The problems with the derivative action are
that it is almost impossible to bring one because of what is
called the demand rule, which is probably the best known body
of law among Delaware lawyers. They all know the demand rule
and the exceptions to the demand rule, and I am good friends
with many of those judges.
Because the derivative action is subject to that very high
burden, the appointment of a special monitor who could sue in
the name of the corporation avoids the derivative suit
problems. It allows you to bring an action as the corporation
suing in its own name, as opposed to a small shareholder going
through a court of equity and seeking to get permission to
commence a derivative action.
It is both a more effective remedy and I think it is one in
which there won't be quite the same compensation problems in
which you may get a cosmetic and meaningless relief in return
for a high award of attorney's fees.
Chairman Biden. I know you have to go, so you should go. I
am not suggesting that your suggestion is not better. I am just
trying to understand whether or not the reason why the
derivative actions are not as useful is because the burden that
has to be met is so high.
Mr. Coffee. It is a very high burden.
Chairman Biden. If that is the reason, or because, even if
the burden is met, it does not result in affecting corporate
behavior.
Mr. Coffee. I think both of those diagnoses apply to some
cases.
Chairman Biden. Thank you for being here. I appreciate it.
With your permission, on your way out, we may submit to you a
couple of questions in writing, and I know you are busy.
Mr. Coffee. I really apologize.
Chairman Biden. No. You hung around here for two hours.
Now, let me continue to pursue that for a minute and ask
any of you to chime in here. Professor Elson, as well as
Professor Donaldson, if you can put on the portion of your
professorial hats that has a historical perspective here, what
is the history of the role of government enforcing these
ethical standards on corporate behavior, building in mechanisms
that are designed as part of the capitalist system to be sort
of self-cleaning, like allowing and incentivizing stockholders
and/or aggrieved parties and/or entrepreneurial lawyers to
enforce proper behavior?
Talk to me about that just a little bit. I am not getting
into any specific actor. Just tell me about what the role has
historically been of those two functions, because my
understanding has generally been the last thing you want is you
want a large government enforcement regulatory role that does
have, I think, the potential to have a deflating sort of impact
upon corporate ingenuity, corporate growth, corporate
innovation.
So talk to me about that, if you will. That is not a very
well articulated question, but I hope you know what I am trying
to get at.
Mr. Elson. I think that the key is how you create
compliance with law within the organization. That is a
fundamental issue. We have attempted lately to create
bureaucratic mechanisms within the organization, compliance
committees and what not, and this comes out of the Federal
Sentencing Guidelines and out of the Caremark case, to do it.
They were, as I think Professor Donaldson pointed out,
ineffective.
The real key is creating within the organization an ethical
culture. That comes from the top, that comes from top
management. And who is responsible for top management? It is
not the government or even those who bring litigation under the
securities laws. It is really the board of directors when you
get down to it. They are the shareholders' representatives who
are there to oversee the organization.
Unfortunately, boards have fallen very short lately, for
the reason that they were typically managers. They were
insiders on the boards or those who were friendly with
management or had relationships to management, which made it
impossible to monitor. That is why modern corporate guidance--
and I am wearing my governance hat now--calls for independent,
long-term, equity-holding directors as the real solution here.
I think those of us in the governance community have been
arguing this for a long time.
Chairman Biden. How do you get there, social
disapprobation?
Mr. Elson. You get there through institutional investors
and the stock exchanges, which they are proposing now, to call
for substantial majorities of the board to be independent, no
financial connection at all to the company other than equity
ownership. Independence gives you objectivity in reviewing what
management is up to. Equity gives you the incentive to exercise
that objectivity.
I think when you have that kind of board, the
whistleblower, who I think is a very important party, has a
group to go to. At this point they don't, where they are
captured by management. If the board is dominated by
management, there is no point in the whistleblower going
forward.
On the other hand, if the board is independent or the audit
committee is independent, obviously there is an incentive there
for someone who disagrees with what management is doing to come
to that body, who are acting in the company's interest as
shareholders. I think that that is really the key, at least in
my view, to a solution.
Otherwise, you are going to have a regime which is fabulous
for the lawyers. And as a member of that profession, I am not
too unhappy about that. On the other hand, it will be form over
substance, and I think that is what we have gotten and that is
why we find ourselves in the pickle we are in.
Every company that has had these ethical issues the last
couple of years all had codes of ethics, compliance programs,
toll-free hotlines, and none of it made a difference.
Senator Sessions. To interrupt there, isn't the board
relying to a large degree on the accounting firm?
Mr. Elson. Yes, absolutely.
Senator Sessions. So the accounting firm is the one that is
supposed to be the paid whistleblower, isn't it?
Mr. Elson. Well, the internal audit and external audit,
yes, they were. Unfortunately, there was a linkage or
relationship between the accounting firms and the managers,
which made it more difficult. And I could go into a lot of
explanation for this as to why they didn't come forward or
didn't look hard enough.
I think one of the problems was they believed that the
audit committee itself was dominated by the management and
there was no point in going to them where there were
disagreements, because you were effectively going back to the
same party. That is why independence on the part of the audit
committee is so critical so that the independent auditors feel
some sort of comfort in going to that group, and having the
auditors report to the audit committee, be engaged by the audit
committee.
Senator Sessions. Just one more little question. So you are
calling for a new kind of board? I mean, the boards that are
presently constituted today, many of them do not have the time
nor the expertise to challenge an auditor or a financial
accounting plan established by management, right? Aren't we
asking a lot of them?
Mr. Elson. No. I am calling for the same kinds of boards; I
think different composition, though. The job of the board is to
monitor, not to run the business, but to monitor.
Senator Sessions. Monitor?
Mr. Elson. Right, and monitor means ask good questions, or
if someone comes to you with a problem, listen to them. But if
you are perceived of as part of management, then no one is ever
going to bother to come to you. Or if you are too linked to
management, you are never going to bother to make an issue, for
fear of being replaced on the board.
That is why independence vis-a-vis nominating committees,
vis-a-vis the audit committees, and vis-a-vis compensation
committees is really the solution. That is what institutional
investors have been arguing for for the last five, six years.
We are moving in that direction. That is the ultimate solution,
at least in my view.
How do you stimulate this monitoring mechanism, known as
the board, to do its job effectively? I think it has to do with
independence and long-term equity ownership on their part. I am
not saying that the board should run the company. That is
silly. They don't have the time, expertise, the will, or the
patience. On the other hand, their job is to hire good
management, monitor good management and, when necessary, fire
bad management.
Chairman Biden. Professor Donaldson, can you give me a
little history lesson here?
Mr. Donaldson. Well, I sense in your question a concern
that I think has been reflected by smart people throughout
history for something other than a command and control model of
managing large-scale entities. It is at least as old as
Montesquieu. It probably goes back to Aristotle.
With the exception of corporate governance changes, I think
the corporate criminal sentencing guidelines are one of the
first and most innovative attempts to try to build in, rather
than impose on, certain kinds of corporate virtues. For that
reason, I found the idea very attractive, and I still do.
In practice, however, with limited resources, what has
happened is that the Federal people have not been inclined to
bring suits against large corporations, have often cut deals
with this phenomenon that one of my colleagues calls reverse
whistleblowing; that is to say the entity will provide
information about usually lower-level white collar criminals
and as a result a few people may go to jail or may be fined.
But the compliance programs themselves are rather ineffective
when it comes to the kind of Enron/WorldCom scandal.
I still believe in that. I wrote about that in a book I
published in 1982; that is, building it in instead of imposing
it from the outside. For this reason, expensing options,
restricting the time in which executives sell shares that have
come from options, requiring shareholder approval of options
plans, all of which have been discussed, I think are critical
adjustments to the mechanism that will realign incentives and
make things different.
In terms of compliance programs themselves, I don't want to
do away with them. But, for example, most of them have these
whistleblowing provisos already built in, but they tend to go
to the legal department. They aren't connecting to auditing.
They need to be changed.
Chairman Biden. Let me say it a slightly different way,
then. Again, I am not trying to make a case for this. I am just
trying to understand. Let me just tell you a little story and
then have you react to it.
I come from the corporate State in a literal sense in terms
of the culture of the State. I was attending a meeting in the
Hotel DuPont and I came out of one of the conference rooms
where they have meetings and a group of high-level executives
from other States were meeting. One individual said I knew said
they wanted to introduce me to these people. There were two
meeting rooms and we just literally met in the hallway.
Most of these people are of a different party than I am,
but this guy supported me and he said, ``I want to introduce
you to my friends,'' and these were major CEOs of major
companies. He introduced me to one and this guy said you know,
I like you very much, Senator, but I don't understand why you
are always with the trial lawyers on this tort reform stuff.
I looked at him and I said, because I am trying to save
your soul. And he looked at me and he said, well, what do you
mean by that? And I said, well, you know, all the incentives
are built in in a way that make it very difficult, with your
fiduciary responsibility to your stockholders, to make some
very difficult decisions. I went through this little thing and
I said, so if you are faced with the following problem I
outlined, which I won't bore you all with, it is a very tough
decision you have.
I said, but if you know that all that can be collected is
the out-of-pocket expenses, the personal injury if your widget
blows up and hurts everybody, you are going to have to ask a
logical question. You are going to bring in your quality
engineer and say how many of these are likely to blow up? And
he is going to say 1,000, or 10,000. And you are going to bring
in your legal counsel and say what is my outside liability if I
do this?
I said maybe you are different. Maybe you will say it is
just wrong and I am going to do the right thing, and get fired
by the board. Then you are going to add it and it is going to
be $20 million to recall this and your total exposure is $3
million.
I said I don't want you to have to make that tough
decision, because let me tell you guys, as Ralph Waldo Emerson
said, society is like a wave; the wave moves on, but the
particles remain the same. We haven't made a new brand of man
in a millennium. Corporate executives are just as good, just as
bad, just as venal, just as noble as everybody else.
For example, I always get the Chamber of Commerce guys
telling me about the coupon case, where one of the airlines
overcharged everybody an average of, I don't know, two dollars.
I forget what the number is. No one customer lost more than
$200 or $500, and yet the lawyer got a $20 million fee. Do you
know what my answer is? So what, so what?
What happens if we found out--and we don't know this, but
let's assume one of the major oil companies just owns their gas
stations and clicks back--for every 100 gallons sold on that
machine, they really only sold 99.7. Nobody, no matter how much
gas they guy, is going to have lost more than $100, $200, $300,
$1,000. It is going to cost them $25,000 or $30,000 to go hire
you or me.
I was relatively good at what I did and I get job offers
that are astounding in the amount of money the law firms want
to pay me to come back, literally astounding to me, anyway, for
a guy of my salary.
It is going to cost a lot of money to sue xyz corporation,
so guess what? It doesn't bother me a bit that some lawyer goes
out and puts together a fund of $6 or $8 or $10 million to go
after the oil company and sue them. The class that is suing,
each person only gets back $175 of what they lost and the
lawyer makes $20 million. What incentive is there other than
pure honesty, pure desire to do the right thing, social
disapprobation? No government is going to come and do anything
about it. The Government didn't go after the tobacco companies,
nor would they. Thank God for Dickie Scruggs. He made obscene
amounts of money. So what?
Now, you guys in the corporations always tell me don't do
criminal penalties and, by the way, raise the bar on the area
where we can get sued because of frivolous lawsuits. And you
are coming along, Professor Elson, and saying, you know, just
do the right thing.
What do we do about this balance?
Mr. Donaldson. If I could add, I spent three days on the
witness stand testifying against the tobacco industry in the
trial that was terminated as a result of a $300 billion-plus
settlement. I think there is a very important role for people
making a lot of money when they create an enormous contribution
in the way that that happened. So I very much agree.
Now, that is not to say that they haven't been used
excessively, class action suits, in some instances.
Chairman Biden. They have. I don't have any doubt about
that.
Mr. Terwilliger. Mr. Chairman, if I may, I just want to go
back to a point that you made before that I think is an
excellent one and deserves emphasis. You really asked what I
think is the right question: How do we most effectively
influence positive corporate behavior?
Chairman Biden. Right.
Mr. Terwilliger. A lot of what we talk about doing of
necessity is dealing with that behavior after it has occurred
and imposing some kind of sanction which may be as the result
of a tort lawsuit. It may be a criminal sanction, it may be a
civil enforcement action.
But there are other issues, I think, that are worth looking
at about how on the front end of that process can we affect it,
and some of what----
Chairman Biden. Can I stop you there?
Mr. Terwilliger. Yes, sir.
Chairman Biden. Don't lose your train of thought.
I am assuming, as I have as a lawyer and as a Senator, that
this does affect the front end. What is the rationale for
punishment? It is not retribution. It is to incentivize someone
to do the right thing. What is the incentive for these civil
lawsuits brought by individual stockholders? It is if they know
it can be brought, they are more inclined not to do it.
So I wouldn't make an artificial distinction here that this
is only after the horse is out of the barn. I assume criminal
statutes we are talking about are to be a disincentive to do
bad things.
Mr. Terwilliger. Of course, yes, and I agree with that and
I don't mean to suggest that they are not.
Chairman Biden. I am not sure how good they are.
Mr. Terwilliger. Well, that is the point. The point is that
if we exclusively focus on those after-the-fact solutions, then
I think we lose the opportunity, and particularly the
opportunity for the Government to be part of the package to
incentivize other kinds of behavior.
The first responsibility is in the corporations themselves.
Then the question becomes what can the Government do? Some of
the things that it can do is remove some of the incentives to
bad behavior and reward incentives for good behavior.
Right now, our whole system of reviewing public accounting
is geared toward singling out those companies who don't do it
right. Why can't the Government and the accounting industry and
business get together and identify what are the best accounting
practices and recognize those companies that engage in them?
That has as very beneficial effect for investors, in that they
know that this company is not playing fast and loose, and I
think there are other things of that nature.
My concern is that if we try to simply deter through
sanctions that we will not really take advantage of this
opportunity to do some other things that can be very positive.
Chairman Biden. That is my whole point. I am not stating it
well. I would like to figure what are those things that aren't
Government regulations or Government sanctions criminally that
can incentivize.
Let me give you an example. I guess it has been six, eight
months, maybe longer, but I was meeting with a personal friend,
a good acquaintance at home, a CEO of a major corporate
company. It was in a social setting.
He said, do you know what galls me? He said, I go up and I
sit down with a bunch of guys on Wall Street who summoned me to
Wall Street. I sit down with three or four or five people--I
forget the number he said, but a small number--average age,
probably 30, and they are looking at me and saying, okay, what
is the next quarter going to be? What are you doing next
quarter?
And he said, well, we are going to continue to build this
and we will maintain the same return on investment next
quarter. No, no, no, that is not good enough. We are going to
have to essentially downgrade your outfit unless you can show
us you are going to have a growth of 1 percent or a profit of
whatever.
And he said I have three options. My first option is I can
tell them to go to hell, and the value of my stock falls, the
value of my company falls, even though I am doing just fine,
but I am not meeting their expectations.
The second thing I can do is I can go home and say, okay, I
can cut expenses. So I go home and fire people, because now
what I have done is my profit margin is slightly higher.
Or, three, I can have a new product in my pocket that I can
put out there, but I don't always have that. So what do I do?
Then they say to me, okay, now part of my compensation, a
gigantic part of my compensation in some cases is the stock
option, and I have ``x'' amount of time to exercise that
option. I am not stupid, Joe. I know if I don't meet these
projections expected of me by these guys on Wall Street, who
don't know squat about my business, the value of that stock is
going to fall.
Now, is he wrong about that? Is that not how it works?
Senator Sessions. Life in the big leagues.
Chairman Biden. That is right.
Senator Sessions. You either have to perform or you get
downgraded, but he has got to have integrity.
Mr. Donaldson. You are running the company for the an
analysts and not for the company.
Senator Sessions. Analysts represent investors, and the
investors have a right to ask questions. But we shouldn't be
whining around here about the poor CEO who therefore cheats to
satisfy some demanding investor.
Chairman Biden. I am not whining about anything. I am just
trying to understand.
Senator Sessions. He has to have the integrity to do the
right thing or else his fanny goes to the slammer.
Mr. Elson. The CEO is wrong to answer you that way.
Chairman Biden. Say again.
Mr. Elson. The CEO is wrong to answer you that way.
Senator Sessions. I didn't like that answer.
Mr. Elson. I don't think it is the appropriate answer. The
answer is most of the institutional investors who are with you
in your stock are indexed, which means they are locked in with
you for the long term. They can't buy or sell. They have got
too much in you and they go on everyone. That is number one, so
they are with you.
If you can convince the world that you have long-term
prospects for your company and you are locked into the stock
long term and you can't take your options, exercise them and
move on--that has been the problem lately. People take the
stock, they sell it, and they leave. The idea is you have got
to be locked in for the long haul.
At that point, I think your decisionmaking as an executive
or as a board reviewing an executive's decision is appropriate.
You can't run a company on a quarter. You have to run a company
over the long term. What happened was I think our incentive
systems went out of whack, not that equity compensation was
wrong, but it was equity compensation that you could sell.
In fact, everyone who has been advocating equity comp for
directors for years has said it has got to be restricted for
your service term on the board. If you allow someone to sell it
short term, you take advantage of informational advantage or
short-termism that in the end is devastating to the company.
Chairman Biden. What is the primary practice right now in,
say, the Fortune 100 companies in America? In the compensation
that they get in stock, are they able to sell it short term or
are they required to hold it long term?
Mr. Elson. Well, you have insider trading regulations that
make it tougher to sell the stock. But as we saw in Enron and
these other companies, people were dumping massive amounts of
stock. That was the problem. And, frankly, I blame their boards
on it, too, because why didn't the board say why are you
selling all this stock? It is a terrible sign to our investors
that you are leaving. If you are selling it, you have obviously
found a better place to put the money.
Chairman Biden. Excuse me. I got that. I understand what
happened. What I am asking you is in most of the compensation
plans--I don't know if there any such study out there, but if
you took the Fortune 100 companies and you looked at
compensation and you looked at the portion of compensation
related to stock, not direct salary, can you generalize for me
or are there any studies done saying that 75 out of 100 of the
top 100 require you to hold it for four years?
I mean, is there any pattern, and has it changed? Something
has happened, fellows; something has happened in the last 15
years. As they used to say when I was a kid, something is
rotten in Denmark.
Mr. Donaldson. That is right, and I don't know of the
studies. I suspect we could find some. Certainly, it is the
minority of business leaders today who are standing up, but
there are few courageous ones, and saying we have all got to
play the game this way; we have got to have limits on when we
can sell the stock and they have got to be significant.
Mr. Terwilliger. I think that is an important point in
terms of the equality of treatment. I mean, let's face it, the
competitors of some of these companies were put at a great
disadvantage in the stock market if these companies were
cheating on what their companies were really worth through
false financial reporting. That gives all of business an
incentive to play it right.
I think one of the things we keep hearing over and over in
this discussion from Professor Elson is the role of the boards.
I really think that illustrates a point that a lot of this has
to do with holding businesses accountable for how they run
their businesses.
Going back to your point of how you incentivize this, there
is no one answer. There are a number of ways in which they are
held accountable, but in our system at least the principal
responsibility is that of the board to the stockholders to make
sure that that business is being run in their best interest,
not in some cadre or group of conspirators among senior
management who are self-dealing.
Mr. Devine. Senator, one suggestion would involve an
expanded model of whistleblower rights. Protecting
whistleblowers is one way to maximize accountability, while
minimizing the size of Government intervention that is a
necessity, but it is only one side of the coin.
The other side is making a difference with their
disclosures. The point of whistleblower protection is to make a
difference, not to make noise, and one thing that I would
suggest for you folks to start considering is a way for them to
have more impact through their disclosures than just putting
something on the record.
Senator Sessions. Getting more what, impact?
Mr. Devine. Getting more impact. There are two precedents
that could be considered. One is the disclosure mechanism in
civil service law in the Whistleblower Protection Act.
Whistleblowers don't just defend themselves under that law;
they can challenge betrayals of the public trust by making
formal disclosures to the Office of Special Counsel, a
Government agency.
If the Special Counsel finds a substantial likelihood they
are correct, they order the agency head to investigate and
report back what they are going to do about it. The Special
Counsel, with the whistleblower's comments, evaluates whether
that was a good-faith resolution of the alleged problems and
places it all in the public record.
Something like that could be developed for the Securities
and Exchange Commission, where whistleblowers could make
disclosures of significant misconduct to SEC, and if the agency
found a substantial likelihood that the charges were well
taken, to order, akin to what Mr. Sporkin did after the
political payments scandals in the early 1970s, a board
investigation and report back on how they were resolving the
problems.
Chairman Biden. Well, you know, there is an old expression:
you have to know how to know. Whistleblowers don't always know.
I mean, we are fortunate if there is a whistleblower in a
position where there is an intersection of information that
they are aware is, in fact, inappropriate.
For example, the report released on Sunday by the Senate
Permanent Subcommittee on Investigations concluded that members
of Enron's board of directors contributed to the firm's
collapse by, among other things, failing to curb the company's
risky accounting tactics and by approving conflicts of
interest.
The report cites several red flags since February 1999 that
arguably should have triggered concern among the board members,
including notice by auditors that Enron was using questionable
accounting methods and requests to waive the company's conflict
of interest policy.
To what extent are directors now held liable for misdeeds
of company executives, and to what extent should they be
sanctioned?
Mr. Elson. I testified before that committee and some of
the red flags that they talked about were some of the things I
talked about in the report. I think the problem on that board
was independence. The red flags were there. I mean, waiving the
code of ethics was an incredible red flag that was missed. That
was extraordinary.
Chairman Biden. Waiving the conflict of interest?
Mr. Elson. They voted to waive the company's Caremark
conflict of interest policy, which is sort of like saying let's
say no speed limits for an hour and see what happens, which
obviously doesn't make a lot of sense.
The point was why did they do it, and I believe that it had
to do with an independence issue. I think that there were
independence problems on that board which caused them, I think,
to view what management was telling them vis-a-vis those flags
not in the same light that others who were independent would
view those flags.
Chairman Biden. How do we get independent boards, then? Do
we just count on this public disclosure generating that?
Mr. Elson. The latest New York Stock Exchange and Nasdaq
reports on corporate governance have called for listing
standards that require majorities of corporate boards to be
independent, and by independent they mean no financial
connection to the company or management other than long-term
equity ownership. I think that that is the key.
Chairman Biden. Didn't they discourage that? Was that not
proposed earlier, as well?
Mr. Elson. Well, no, it has never been proposed. The
institutional investors and the Business Roundtable that five,
six years ago and it never went anywhere.
Chairman Biden. Why?
Mr. Elson. Well, I think that there were a lot of
management who didn't want to have an independent board, for
obvious reasons.
Chairman Biden. Bingo.
Mr. Elson. Yes.
Chairman Biden. So it didn't get adopted.
Mr. Elson. Well, it began to be adopted. You have seen
many, many companies over the last four or five years that have
moved to substantial majority independent boards based on
investor pressure. Large institutions--Calpers, TIAA-CREF, the
New York State and City funds--put pressure on boards to reform
and you began to see changes.
Chairman Biden. In the meantime, though, a lot of people
are dead. I mean, it is a little bit like saying we need more
cops in a crime-ridden area and the public is going to put
pressure on the local councilmen to vote to do that, but it is
going to take a while here and my neighborhood is still--I
mean, I don't get your guys.
Mr. Donaldson. There are always clever things that can be
done. In the Enron case, for example, the audit committee, sort
of the focus on the problems--half of the people lived outside
the country. Everybody on that six-member board had something
big in their pocket from Enron, and the head of the audit
committee had been there for 13 or 14 years. This is very bad
practice. So some of the reforms that are working on board and
audit committee relationships to the corporations and other
systems are important. I like, for example, the idea of having
the audit committee pick the outside auditing firm instead of
having that picking being done by the CEO.
Mr. Elson. They should have done that to begin with. You
are absolutely right. To begin with, the reporting line should
have been to the audit committee. But these changes have been
taking place over the last couple of years. I think what you
have seen are outliers. Listen, I believe strongly in
substantial majority of independent boards. I would go beyond
simply majority.
Chairman Biden. Let me tell you what worries me. In a
sense, this whole subject is above my pay grade. This is not
something I claim any expertise in. I am going to say something
outrageous.
Regarding the criminal justice system and criminal behavior
that is violent criminal behavior, I believe I know as much
about that as anybody who has served in the United States and
almost any criminologist in the country, not because I am so
smart, but for 30 years I have listened to every single expert
we could find, and I hope I am not stupid.
This is above my pay grade, in a sense. But do you know the
people I listen to? I listen to the people who, in fact, are
deeply invested in this capitalist system, and they have
concluded, in my view, that this is a systemic problem. This
isn't a few bad apples; this is systemic.
You have the Nasdaq at a five-year low after the
President's speech. You have the Dow down to 8,813 at the close
of business today. You have almost every major business leader
I know and not because I am important--I think I am probably
the only guy in the United States Senate, and I am not proud of
this, that does not own one stock, one bond, one debenture, and
never has.
I had a stupid idea when I was 29 saying that was an
inherent conflict, and I am inherently poor. It was dumb, so I
am not suggesting that I know much about this, about how the
system works. But I will tell you what. When the guys and women
who rest upon making it off of this believe, whether it is true
or not, that they haven't seen the bottom of this yet and they
believe it is systemic--and I hope I am proven to be wrong, but
let me tell you something. They are voting with their dollars
right now, and I will be dumb-founded and overjoyed if six
months from now we gather for a reunion and there have been no
more Enrons, there have been no more WorldComs, there has been
no more significant readjustment of major corporate assets.
Senator Sessions. Mr. Chairman, one reason we will probably
see some more is because when things are going well, it is not
apparent.
Chairman Biden. Exactly.
Senator Sessions. It is when things go bad and the prices
drop 20 percent and all of a sudden you can't pay dividends. So
I suspect we may find some more, but I don't know that it means
the entire financial structure is compromised.
Mr. Donaldson. If I could add, I think, too, everybody is
stripping down to their underwear at this point to prove they
have nothing to hide.
Chairman Biden. I agree with that.
Mr. Donaldson. So we are going to see a little of that for
a while.
Senator Sessions. It is healthy.
Mr. Donaldson. It is systemic, but we will pull out of it.
Chairman Biden. I think we will pull out of it.
Mr. Donaldson. I think the question it will be interesting
to ask is two years from now, will we be able to say the
reforms that we put in place--I don't know how we got along
without them all these years. That is the way I want that
question to be answered.
Senator Sessions. Mr. Chairman, I wanted to pursue Mr.
Devine's whistleblower idea. And, George, maybe you can comment
on this.
We have the qui tam provisions in Federal contracting law,
where a person can reveal a fraud that hurts the Government in
a Government contract, and then a lawsuit can be filed and they
are paid 15 percent of the recovery. You have to have, a person
to report to though.
I had a person come to me when I was in private practice,
and you call the Department of Justice and try to get them to
file it. If they don't, you can file it yourself.
Should there be within the corporate structure of major
corporations a committee that the employees all know that they
can take a complaint and a concern to?
Mr. Devine. I think there does need to be--and as the other
witnesses have pointed out, there has been a lot of these
committees created. The Achilles heel has been conflict of
interest.
Senator Sessions. George, you have been a prosecutor. If a
person comes into this committee, and at least if they write
down the complaint and everybody on the committee sees this
complaint and says there is nothing to it, and George comes
along about two years later and starts investigating them for
criminal fraud and you are looking to prove knowledge, that
puts them in a big hurt, doesn't it?
Mr. Terwilliger. Yes, it does, and I think in terms of the
internal whistleblowing and reporting process, part of what we
hear here from the two ends of the table alongside me are two
different considerations.
One is the concept of whistleblowing and having a place to
take these complaints. Frankly, when companies ask me about
that, I say that is a great idea. Who would you rather have
them report some alleged fraud or malfeasance to, you or some
outside lawyer who is going to file a lawsuit?
Senator Sessions. The FBI.
Mr. Terwilliger. Or the FBI, that is right. Giving the
company a chance to deal with it proactively to begin with is a
good idea.
What we hear from the other side is whether or not it works
the way it is set up. Is there a compliance process that this
goes into, and does that work well or not? I dare say that
every corporation in America is probably asking itself that
very question about its own internal processes now, which is a
good thing to come out of this.
I would like to just react further for just one second to
what the chairman mentioned before about not seeing the bottom
of this yet and what not. It is far too late in the day to pick
a fight with the chairman, if there is ever a time to do it,
and I am not intending to do that.
But I do think it is important that if there are systemic
deficiencies that allow this to happen, that is one thing. That
is different than saying that this kind of cheating and this
level of dishonesty and disloyalty to corporate duty is
systemic in and of itself, because I don't think that is true.
I don't think that most corporations are like those
outliers that we have seen now, and we do a disservice to
ourselves and to our economy and to investors if the perception
is that we are generally vilifying corporations, which I don't
think the chairman intended to do and I don't think that is
what he was saying.
I do agree that we are in a horrible crisis now, and stock
prices are very low, Mr. Chairman, and maybe if you were ever
tempted to buy, this would be a good time to do it.
Chairman Biden. I don't have enough money to buy now.
Mr. Devine. I have a little more to offer in answer to your
question, Senator. We have been involved in an experiment for
those types of committees that seek to break through the
conflict of interest. It is a form of alternative dispute
resolution, a committee sponsored by the company that the
whistleblower can go to.
We tried it with the Westinghouse Corporation out at the
Hanford nuclear weapons site, a Government contract facility,
and the committee they bring their concerns to has a balanced
representation from the board of the company, Government
representatives to observe, and citizens organizations.
Something like that could be adapted to the shareholder
institutions, the institutions of a corporation.
If someone raises their issues to that committee, there is
a general pledge and consensus that they cannot be retaliated
against for working through that option. It has had a healthy
impact; it has been a real change. It is not a panacea, but it
has had very visible results.
The other suggestion would be going right to the example
that you used to illustrate, the False Claims Act. I think that
it is worth considering adopting that model to a fraud against
the shareholders. Right now, it is just fraud against the
Government in contracts. This would be a way to slice through
the conflict of interest if whistleblowers had standing to sue
on behalf of the shareholders when there was fraud that
threatened their investments.
Senator Sessions. The people here that are victimized are
the shareholders ultimately, and they are trusting to corporate
leadership and they are willing to accept bad judgment. The
company tries a new product line and it fails and everyone
loses their shirt. People can accept that, but they are not
willing to accept being cheated, and they shouldn't.
I do think usually there is somebody in the system who
knows about the problem and should bring it forward if they
have a convenient place, and perhaps the qui tam might be a way
to do it.
Mr. Donaldson. Could I just insert one thing?
Senator Sessions. Yes.
Mr. Donaldson. The kinds of deep, almost catastrophic
shenanigans that have been revealed recently would be very
difficult for any of the sort of compliance model, information
line, hotline, open-door policies to handle. I just want to
make that point.
Senator Sessions. But you could have had a----
Mr. Donaldson. I am not saying we shouldn't have them and
we shouldn't try to improve them.
Senator Sessions. But do you think there is somebody at,
say, Enron that saw the accounting problems here at an earlier
stage and could have expressed concern to somebody?
Mr. Donaldson. Absolutely.
Senator Sessions. One more thing. Judge Griffin Bell, a
former Attorney General of the United States, discussed a
problem with me when I was Attorney General of Alabama. He was
dealing with a company that may have acted improperly regarding
some commercial contracts, retail-type contracts, and they were
concerned about doing the right thing.
You can be sued in any State in America for fraud, and they
want to come forward and they wanted to pay everybody, but they
were terrified they were going to get sued in a big class
action and the whole company would be in danger. I think they
eventually came up with some way to do it, but there is not a
real mechanism in America today for a board to say, wait a
minute, we have been doing this kind of procedure for many
years. We have cheated our customers or they have lost $100 a
piece and we are willing to pay them. But if each one of those
people are going to then sue them for $100 million in every
State in America, the whole thing gets awfully scary.
Should we have some mechanism by which a company can self-
report and pay just compensation, maybe even some penalty in
addition, but it wouldn't turn into a massive litigation
frenzy?
Mr. Terwilliger. Well, I will respond to that in part,
Senator Sessions, that at least in the first instance on
criminal sanctions, the fact of the matter is that voluntary
disclosure programs generally do not work because the
incentives for doing so are outweighed by the risks, including
the risks of lawsuits, the risks of being prosecuted.
Senator Sessions. Don't you think the risk of civil
litigation is probably worse than being prosecuted?
Mr. Terwilliger. It is at least as bad.
Chairman Biden. Not for any corporate executive I know.
Give me a break, give me a break.
Mr. Terwilliger. No, no. I think, Senator, we are talking
about the corporation itself.
Chairman Biden. I got that. I have found, though, at the
end of the day they don't sit there and think, oh, my God, the
corporation. They are sitting there saying, oh, my God, me.
Mr. Terwilliger. That is a good point. Again, I think that
is why some other types of alternatives to affect the corporate
behavior of managers is important. God help me if I wind up
representing one of these people on this kind of an issue, but
I think the idea of expanding the sanction of banning someone
from serving in a position of corporate responsibility in a
publicly-held company is a very good incentive because a lot of
people think that the risk of engaging in dishonest behavior is
worth it. Even if they wind up paying some kind of a price for
that act, they believe they will get back in the game. If what
they are talking about doing is giving up a career completely,
I think that helps to change the equation.
Senator Sessions. The example I am giving is if self-
reporting an action that might be marginally criminal, the
person might feel like they are really not going to be
prosecuted if they go to the prosecutor, the U.S. Attorney, and
lay it all out and say they have got a plan for correction.
Maybe it is a regional manager for the western United States
that has been doing a contract in a satellite dish deal and
they found out the way they are doing it is wrong.
Mr. Terwilliger. It would probably be procedurally
difficult to insulate them from civil liability, but it
certainly might be a way to avoid punitive damages, mitigate
damages in a case.
Senator Sessions. Judge Bell feels very strongly about it
and probably would write us his opinion on it.
Chairman Biden. Let me proceed along these lines just a
little while, and we realize we are really trespassing on your
time, but it is seldom we have this much fire power here to
help us out.
If you take a look at WorldCom, they now say that 40
percent of its investment last year was really operating
expense. Now, I understand that cooking of the books is fairly
simple trickery, but the company just simply stated that
routine operating expenses were capital investments, which had
the effect of inflating the profits extraordinarily.
Now, I am no accountant and I am no expert, but that little
math gimmick strikes me as the kind of basic accounting that
students in 101 at the University of Delaware would understand
was inappropriate. Yet, WorldCom's auditors didn't catch it.
Arthur Andersen, which reportedly was paid $4.4 million to
certify its books, didn't detect this seemingly simple trick.
The board of directors didn't seem to know it.
How could WorldCom fake nearly $4 billion in expenses? How
could the regulators, the auditors, the analysts, the banks
have missed this possibility of corporate fraud? What am I
missing here?
Mr. Donaldson. Classic cases, long Harvard Business Review
type cases, and business ethics for decades have had accounting
fudging, pushing the envelope in accounting, as an issue. But
what we have seen in the last five years is brazen pushing of
the envelope, of the WorldCom type.
I think you have just got to face the fact that the climate
has changed. With all the emphasis on short-term stock value,
driven by some of the Internet shenanigans earlier, and with
stocks constantly rising, corporate officers have been willing
to make amazing accommodations with accounting tricks.
Chairman Biden. You sound like you are from the State
Department.
Mr. Terwilliger. Mr. Chairman, I think that the fact of the
matter is--and I am not an accountant and I can't speak to
specific treatments in specific circumstances. One of the
oldest tricks in the book in accounting and financial reporting
fraud is to, in fact, capitalize what should be annualized
expenses.
There are rules that govern this. These rules are not
necessarily ironclad principles that reduce proper accounting
treatments to black and white. I have been involved in cases
where there have been great arguments about when inventory can
remain valued as inventory and when it is no longer of any
value or not of the same----
Chairman Biden. I got that. I was on the other side of you
guys. I was a public defender, and I still got elected. When
someone recklessly endangers another person's life, they can
get convicted of manslaughter and they can go to jail for a
long time. And they didn't have to intend to kill anybody. They
had to know that this reckless behavior might result in that
happening.
Yet, on the white collar side of the equation, right now
the WorldCom situation--and you guys are former prosecutors--
under current law, the prosecutor has to prove that the
defendant actually knew and took part in the fraud, not just
was incredibly and willfully or recklessly negligent.
When I can be convicted of manslaughter for recklessly
behaving if I cost the economy--and I mean talk about driveby
shootings. This has been a driveby shooting. There are a whole
heck of a lot of people who are in real trouble who were no
part of WorldCom, didn't own any stock in WorldCom, didn't have
anything to do with WorldCom.
Look, there is a Brazilian company at WorldCom. You know,
talk about this being internationalized, for example,
WorldCom's largest international subsidiary was a Brazilian
long-distance company. Their stock dropped even after it was
absolutely clear that it was operationally and financially
independent of WorldCom. Talk about a driveby shooting in a
country that is already in deep trouble, whose economic system
is in dire straits, and boom.
Should we have a standard in the law that says if you are
recklessly negligent?
Mr. Terwilliger. Well, we do to a certain extent in the
criminal law of fraud on the Federal level have that standard
in the sense that the legal term is ``conscience avoidance.''
As a practical matter, what it means is turning a blind eye,
and prosecutors can substitute evidence of turning a blind eye
for actual knowledge and obtain convictions of individuals on
that basis. So you can't simply say ``I don't see.''
The concept of recklessness, I think--and again I am not a
law professor, but the concept of recklessness is inconsistent
with the notion of fraud, which is an intentional
misrepresentation or concealment.
Chairman Biden. Well, I would argue it is no more
inconsistent than the notion of murder or manslaughter.
Mr. Terwilliger. Well, that may be a legislative judgment,
frankly, Mr. Chairman, to make to make that a crime, but I
don't think that is fraud as we have known it to date.
Senator Sessions. Mr. Chairman, I am kind of interested in
that because you are raising a good point. My observation is
when you talk to the business community and the prosecutorial
and law enforcement community, it is like they have entirely
different visions of that animal we are dealing with.
The business community is just terrified. They sign all
these documents everyday, the regulations that come in. People
around them are signing documents, just like we do. People sign
our names to things we don't even read and they are going out
all over the place and they think they are going to be put in
jail for it. So they don't want to strengthen the power of the
Government's hand. It terrifies them because they are honest
and they think they might be dragged before the bar.
Chairman Biden. A legitimate concern.
Senator Sessions. But the truth is we need to focus some
way on criminality here. We talked about it earlier. Maybe the
punishments could be less for these kinds of reckless matters.
What do you think, Professor Elson? It is making you
nervous, I can tell.
Mr. Elson. Well, yes. If the goal here is shareholder
protection, which is the whole point--I have got my retirement
monies in TIAA-CREF, the teacher's retirement fund. So, you
know, I am in the equity markets as a potential retiree, too.
Chairman Biden. If you were in California, you just lost
$580 million.
Mr. Elson. In TIAA-CREF, I just got my statement and I have
lost quite a bit, too.
The bottom line is protecting investors' money, because if
we don't in the long run what happens is nobody invests and our
whole system stops. The key to investor protection is
confidence in the markets so people will invest. The question
is how do you get to the goal of preserving company assets and
shareholder assets.
What I fear in changing the standard to recklessness is
that you will create avoidance procedures on the part of
management, who will develop all kinds of legal regimes,
compliance procedures and what not, to avoid that kind of
prosecution, which in the end I fear will take the focus off of
preventing wrongdoing and instead simply avoiding liability.
That is terrifying to me as an investor and I think that is the
bottom line.
I want management and the board working for the investor,
period, and when their goal is taken off of that and focused
instead on avoiding some sort of a liability, then I think you
have got a real problem in the system.
Senator Sessions. As a prosecutor, I prosecuted several
cases that I personally tried that dealt with fraud charges
that pivoted around values of properties. And I am telling you
it is a difficult deed to convict somebody on anything when you
are dealing with value. It is like pornography; I know it when
I see it. I know this property is not worth this much. He
loaned two times its value, but somebody somewhere said it was
worth ``x.''
Oil prospects in Texas was one case we tried. So what is it
worth? It wasn't worth what they said it was, but it is
difficult indeed to prove beyond a reasonable doubt when you
have got some witness to say, well, it could have been worth
that much. So my prosecutorial instinct here is that we have
got a lot of people getting off the hook on some things that
are difficult to prove.
Chairman Biden. I would note that most of the U.S.
Attorneys I have had the privilege of suggesting should be
appointed by the President of the United States over the last
three decades and most of the Attorneys General that I know are
not crazy about picking up these suits. And it is not because
they are not good guys. It is because they are incredibly time-
consuming, they are incredibly difficult to prove, they are
incredibly complex. And if they have an ambition to demonstrate
that they, in fact, can protect society, they can pick up three
or four murderers in the time they get one of these major cases
through.
Senator Sessions. And if it blows up and their case falls
apart, then they are ridden out of town on a rail.
Chairman Biden. And most who are appointed and want the
jobs don't come from the civil side of the equation. They are
not the lead corporate counsel in a large law firm who wants to
be a U.S. Attorney. They are usually somebody else.
I won't keep you much longer, but if the Lord Almighty came
down and sat in the well there and said, okay, you get to have
one reform, one thing that would change in order to sort of
reconstruct the appropriate corporate culture, reconstruct the
notion that there is transparency, reconstruct or elevate
competence in the system--if you only got one, what would you
pick, what one thing, Professor Elson?
Mr. Elson. Very simply, truly independent, long-term,
equity-holding boards, period.
Mr. Terwilliger. I agree with that.
Mr. Donaldson. That actually combines a number of items. I
was going to say limitations on the sale of stock acquired by
options, but that is part of the issue here.
Mr. Devine. Predictably, my dream would be around
whistleblower rights, and since you passed the reprisal
protection in the Senate today, I get to switch to helping them
make a difference. My suggestion would be to apply the False
Claims Act model to whistleblowers who are suing on behalf of
the shareholders of the corporation.
I would point you to the track record with Government
contracts. In 1985, the last year before the False Claims Act
was modernized, the Civil Division of the Justice Department
collected $26 million in civil fraud recoveries. That increased
exponentially the first decade after the False Claims Act was
passed to average about $200 million a year. Last year, in one
suit alone, the Justice Department collected over $850 million.
This is a highly effective remedy if the internal reforms of
more reliable boards aren't sufficient.
Chairman Biden. Did we do the right thing, and does it
matter, in the elimination of joint and several liability in
security fraud cases?
You get a dispensation, Mr. Terwilliger. You need not
answer that.
Mr. Terwilliger. Thank you, sir.
Chairman Biden. What do you think? Did we do the right
thing?
Mr. Elson. I believe so. I supported the reform.
Chairman Biden. I am just taking that one provision. I am
not talking about the whole thing. You have outside accounting
firms saying the inside accounting operation should have known
it. The company goes bankrupt. The thing that is left is the
accounting firm, although that is not the case now. Well, think
about that one.
From my perspective--and I will end with this and anybody
who wants to comment on it, you are welcome to. What we will do
is rather than keep you longer, I have several questions to ask
each of you in writing, if I may. I have kept you here until
7:30 almost.
From my perspective--and I have a lot more to learn here
and I would rather make no law than bad law right now--it seems
to me there are multiple pieces to what has evolved in a
culture that is not merely a corporate culture, but a culture
that we have seen sort of the aberrations in the dot.com--I
mean, this notion that we are global, we are interconnected,
everything is in a moment, everything requires immediate
gratification and impact for your stockholders, for your
investors.
It seems to me we have to address four or five things, and
I don't know the answer to each of them, but I am going to ask
you to think about this. If you want to comment now, fine. If
not, I would appreciate it for the record.
One is we have spurned the OECD initiative regarding the
tax shelters offshore. It seems that we have incentivized
people to do things that don't make any sense. We have to do
something relative to the notion of how we deal with stock
options. You folks have spoken about that.
Thirdly, we have to have what the Sarbanes legislation
primarily focuses on. We have to deal with the whole notion of
transparency, accountability, responsibility of accounting
firms, separating accounting and consulting, and
disincentivizing people from doing things on hard decisions
they have to make.
We have to deal with the criminal penalties side, which
this committee is focusing on, and we have to at least go back
and look at the private sector, the legal community, the
stockholders' availability to initiate on their own civil suits
that have nothing to do with government involvement at all; at
least go back and examine whether what we have done was, in
fact--did we go too far, or did it have no impact on part of
what is happening now? Lastly, unrelated in a direct sense, we
have to figure out federally how to deal with the whole notion
of pension protection in ways we haven't addressed yet.
So I want to make it clear to you I don't think there is
any one answer, and I want to make it clear to you how much I
appreciate the fact you have just been sort of brainstorming
with us here. If I had all the answers, I would be the first to
tell you I thought I did, but I don't.
Mr. Donaldson. Senator Biden, can I interrupt and add just
one item to your list?
Chairman Biden. Please.
Mr. Donaldson. I am resistant to legislation in this area,
if there is any other way of handling it, but I do think the
issue of the relationship between investment banks and analysts
is part of this whole cultural issue.
I will never forget being in front of dot.com presidents
about a year-and-a-half ago, about 300 of them, asking them if
a person came to you from a large investment bank and said,
sotto voce, you know, we can ensure that your stock will be
valued high, but we do want you to do your investment banking
with us, how many of you would do it? Ninety percent of the
people in the room raised their hands. Then, of course, they
turned and said but it is their responsibility in the
investment banks, not ours.
Chairman Biden. I agree, and I mentioned that at the
beginning of this hearing because there is such a symbiotic
relationship there. A 60-second digression here. When every
foreign, newly-emerging democracy comes to me and to the
Senator and others and says, help us with our constitution,
talk to us about it, what is the most significant thing that
your Founding Fathers had--they are looking for little nuggets,
and I say the most significant thing about our Founding Fathers
was they took human nature as it was, not as they wished it to
be, and they wrote it in; they wrote it that way.
I realize they should step up and they should do the right
thing, but the idea that if I go to xyz investment banking
company and they get a piece of the action and they are the
ones who are going to rate me and they are the ones who are
going to sell me--and the ability of the human mind to
rationalize should never be underestimated.
At any rate, I would like to put into the record Senator
Leahy and Senator Hatch's statement. So I ask unanimous consent
to do that.
Chairman Biden. I will leave, as is appropriate, the
closing questions or comments to my friend from Alabama, and if
he has none, invite any of you to make any closing comment at
all on anything at all.
Senator Sessions. I would just say, Mr. Chairman, that I
won't go into it now, but I think Mr. Terwilliger understands
that the SEC really is where a lot of this stuff is first
identified, and the relationship between the SEC and the
Department of Justice and the prosecutors and/or the FBI
sometimes is really important to enhancing the identification
of actual fraud.
I truly believe that if a whistleblower comes forward with
a complaint today, every board in America is going to pay a lot
more attention than they would have six months ago. So it is a
painful catharsis we are going through here, but I believe the
net result is going to be more integrity in our financial
markets and more integrity in corporate leadership.
The American people are angry and they are losing money.
The best thing about the American democracy is there is nothing
better.
Chairman Biden. Well, I wouldn't agree with you more. One
of the reasons you have got folks like McCain and others
calling for Mr. Pitts' resignation is because he has the SEC,
Securities and Exchange Commission, and he was one of the main
arguers against the stock exchanges changing some of the
regulations you call for here.
You know, the President called for a corporate fraud task
force. The thing I want you to think about is what about
basically a shareholders fraud task force and people leading
that?
Again, I can't tell you how much I appreciate it. If any of
you have a closing comment, I would be happy to hear it.
Mr. Terwilliger. Mr. Chairman, I just want to say thank you
for the opportunity to be here with you and Senator Sessions
and your colleagues to talk about these very important issues.
I am honored to be here.
Chairman Biden. Well, I thank you all. We are truly honored
to have such a distinguished panel. I will warn you, we may
call on your later. I like to think we are out of the woods and
we know what we are doing, but I am not sure we do yet, and so
we may need some additional help.
I will have some questions, and I will leave the record
open for other Senators to submit questions. I don't want to
overburden you. I know you are all busy, but we would like to
ask some questions that we didn't ask tonight.
With that, I again thank you for your indulgence.
Thank you for being here. We are adjourned. [Whereupon, at
7:33 p.m., the subcommittee was adjourned.]
[Submissions for the record follow.]
[Additional material is being retained in the Committee
files.]
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ENSURING CORPORATE RESPONSIBILITY: USING CRIMINAL SANCTIONS TO DETER
WRONGDOING
----------
WEDNESDAY, JULY 24, 2002
United States Senate,
Subcommittee on Crime and Drugs,
Committee on the Judiciary,
Washington, D.C.
The subcommittee met, pursuant to notice, at 2:39 p.m., in
room SD-226, Dirksen Senate Office Building, Hon. Joseph R.
Biden, Jr., Chairman of the Subcommittee, presiding.
Present: Senator Biden.
OPENING STATEMENT OF HON. JOSEPH R. BIDEN, JR., A U.S. SENATOR
FROM THE STATE OF DELAWARE
Chairman Biden. I want to thank you for being here, number
one. Number two, I apologize for being a few minutes late. We
just got finished voting on an issue and some of my colleagues
will be coming in late. I have a relatively brief opening
statement, after which I will turn to our witnesses.
I would like to welcome you all to the third in a series of
hearings I am holding on white collar crime and the adequacy,
or shall I say the inadequacy of penalties for white collar
offenses.
Way before the truly mind-boggling events of WorldCom, we
were exploring this question of corporate responsibility and
the extent to which so called white collar crime offenders
should be held accountable in the criminal justice system.
Embarrassingly, it is a question that has for years evaded this
body, the courts, and the overall criminal justice system.
I say embarrassingly because the answer to the question
strikes me as painfully obvious. Of course, white collar
criminals should be treated as harshly under the law as petty
thieves or drug dealers. Yet, our policy prescriptions have
been muddled. Indeed, the institutions that oversee crime
policy, including the U.S. Congress, have been a bit
schizophrenic on this issue.
I have been deeply troubled, as all of us have been, by
recent events in corporate America. Even more disturbing has
been the impact these scandals have had on investor confidence
and this country's economic well-being, at least for the
moment.
In concert with an already sagging economy, allegations of
corporate malfeasance have resulted in plummeting stock prices,
a drop in consumer confidence and consumer spending, and rising
unemployment in an otherwise stable economy. With about 60
percent of all American households invested in the stock
market, we have become a nation of investors, and if we are
unable to preserve investors' confidence, the markets will
continue to plunge, and with them the health of our economy.
Today, we will address these questions in light of
Congress' ongoing effort to pass accounting reform legislation
and the real-world spiral we are now witnessing. There are
three things I think we have to do immediately: first, toughen
in a rational way criminal penalties. As I mentioned, Senator
Hatch and I secured passage of a bipartisan amendment that
passed without a dissenting vote in the Sarbanes accounting
bill that would enhance the underlying criminal penalties for
fraud, for conspiracies to commit certain white collar crimes,
and for violations of pension protection measures.
Most significantly, our amendment also includes a provision
that imposes criminal penalties on top corporate officials who
lie about their company's financial health. Should we expect
anything less than accurate financial statements from corporate
officials?
Let me be clear. The legislation we passed and is being
mulled around in conference now would not hold any corporate
executive or chairman of the board liable for negligence. It
would only hold them liable if it were proven beyond a
reasonable doubt in a court of law that they knowingly and/or
willfully misled the SEC.
That is why Federal Reserve Board Chairman Alan Greenspan
last week testified before the Senate Banking Committee that
imposing criminal sanctions on CEOs who knowingly misrepresent
the financial health of their companies is the key to real
reform in corporate wrongdoing.
The second thing we must do is insist on more transparency.
I won't belabor the point, given our recent and extensive
debate on accounting reform, but suffice it to say that we need
truth in auditing and truth in accounting. Top executives must
be compelled to provide investors with clear, accurate
financial information. If they don't, they should be held
accountable. And if they don't and they are not confident of
it, investors might as well go play the lottery as invest in
stock.
The third and final thing we need to do is enable citizen
suits. I may be in the minority on this view. I was one of a
handful of Senators to vote against the so-called Private
Securities Litigation Reform Act of 1995, which was ultimately
enacted over President Clinton's veto. I opposed this anti-
investor bill because it severely restricts the ability of
defrauded investors to recover their hard-earned dollars.
What we are seeing today in the form of corporate abuse, in
my view, is the quintessential chicken coming home to roost. I
know I won't win many friends by saying this, but we are
beginning to see the true consequences of this anti-investor
provision included in the 1996 legislation. And if we are
serious about ensuring corporate responsibility, we need to
make sure that defrauded investors are able to bring legitimate
suits to hold corporate wrongdoers accountable and to recover
their losses.
Finally, I believe that in the accounting reform
legislation, which is in the House-Senate conference this week
as we speak and includes the bipartisan Biden-Hatch amendment,
it is important to step up to these problems. I hope we will
soon get a bill that preserves fundamental reform initiatives
and invites the President's signature.
We have assembled here today a truly blue ribbon panel of
witnesses. I am not suggesting by my opening statement that
they agree with anything that I had to say, but they will have
their own opening statements and I am eager to hear our
witnesses.
G. William Miller is the chairman of the merchant banking
firm of G. William Miller and Company. He has a wealth of
experience both in government and in business. Mr. Miller was
Chairman of the Federal Reserve Board from 1978 to 1979.
That is when I first met you, Mr. Chairman.
He served as Treasury Secretary under President Carter from
1979 to 1981. Secretary Miller is also a businessman who rose
through the ranks of Textron to become the Chairman and CEO,
and now runs his own company. We look very much forward to his
statement.
I would also like to welcome Roderick M. Hills, another
distinguished member of our panel. He was Counsel to the
President and Chairman of the Securities and Exchange
Commission under President Ford, who, by the way, is one of the
finest guys I ever served with. He currently serves on the
board of directors of three corporations. In addition, Mr.
Hills has served on the boards of 16 corporations. In 13 of
those positions, he was a member of the audit committee,
responsible for ensuring that no one was cooking the books. We
look forward to hearing his comments.
Mr. James R. Doty is a partner in the law firm of Baker
Botts, LLP, and is head of the corporate and securities
practice there. He was a former General Counsel of the
Securities and Exchange Commission between May of 1990 and
December of 1992. He is a graduate of Yale School Law, which is
the only thing I hold against him, and has written a number of
articles regarding securities legislation. We are glad to have
him here.
My son is a graduate of Yale Law School and I point out to
him, having graduated from Syracuse Law School, that he really
didn't attend a law school. It happens to be the number one
rated law school in America, but we refuse to acknowledge that
in my household.
Mr. Doty. Many people agree with you, Senator.
Chairman Biden. His brother went to Syracuse, as well, but
my son responds that it takes two Syracuse law degrees to equal
one Yale law degree. So I don't know what the story is here.
I thank you all for being here, gentlemen, and I can't tell
you how much I am looking forward to your testimony because of
the wealth of experience you all bring to the table.
Maybe, Mr. Secretary, if we could begin in the order that
you were called, I would welcome your comments and then maybe
we can have a discussion.
Secretary Miller?
STATEMENT OF G. WILLIAM MILLER, FORMER SECRETARY OF THE
TREASURY, FORMER CHAIRMAN OF THE FEDERAL RESERVE BOARD, AND
CHAIRMAN, G. WILLIAM MILLER AND COMPANY, WASHINGTON, D.C.
Mr. Miller. Mr. Chairman, thank you very much. It is a
pleasure to be here and I appreciate the opportunity to comment
because the subject that you are addressing is obviously
enormously important to our economy and to the well-being of
the American people.
Momentous events have occurred in the last year. 9/11
certainly exposed us to a foreign threat of unprecedented
magnitude and unknown sources of danger to our country. But the
parallel threat from what is happening through the breakdown in
corporate accountability and responsibility is equally a
threat, a domestic threat to our well-being.
There have been corporate and business crises before. This,
of course, is of unusual magnitude, not in just the number of
companies that have been in trouble, but also the amount of
values that have been destroyed. Not only have the savings and
hopes of the employees and families of these companies been
impacted, but the loss of capital values since Enron announced
bankruptcy has exceeded the gross national product of any
country in the world other than the United States.
Chairman Biden. I never thought of it in those terms. That
is kind of staggering when you think of it in those terms.
Mr. Miller. It is an amazing destruction of values that has
occurred. And while, yes, we have had difficulties in the past,
that is certainly something that brings the issue home and
focuses our minds, all of us, on the importance of seeing why
this has happened and how we can assure that it will never
happens again.
It is not possible to legislate honesty, but any civilized
society will want to have rules of law that deter criminal
activity and protect society against dishonesty that can have
even minor impacts, not to mention the huge impacts that we
have seen recently.
I just want to note, however, that my testimony is not
based on my experience in criminal law, in which I have little
experience. My testimony is based upon my corporate management
experience and my Government experience, and it is in that
context that I would like to give you my thoughts.
The Federal Government's response to this crisis has been
remarkably swift and comprehensive. Even a few months ago it
was very much doubted that the Congress could act so quickly to
bring into control a situation that seemed to demand action.
The fact that the House and the Senate could pass comprehensive
legislation so quickly is quite impressive.
I understand that the conference committee on the two bills
was able to reach agreement today, so we will soon see what the
structure of the final proposals will look like. We not only
have the congressional action, but, of course, the SEC has
responded with its own proposals and the President has put
forth his plan.
Your subcommittee has had a good deal of testimony about
the nature and the characteristics of white collar crime. So I
don't want to dwell too much on it, but it is an area that has
its own degree of difficulties.
Quite often, white collar crimes are committed by people of
above-average education and above-average intelligence who
stand in legitimate roles in society and have the capacity to
use deception and stealth to carry out their plans with
remarkable effectiveness. It is hard to ferret them out, and it
is hard often to prosecute them because they can obscure the
facts so easily.
As a consequence, this inherent charactristic makes it very
difficult to know how to apply the deterrent effect that you
are seeking through your amendment to be sure that corporate
responsibility is assured.
Financial accounting, which has been the root of much of
this problem, is a field that involves many estimates and
judgment. As a result, it offers an opportunity to disguise
misrepresentation because there are so many elements that can
be hard to understand or to comprehend.
Corporate structures also are becoming very complex. Most
companies now are not confined to a single-product line. They
have multi-product lines. They have operations in many areas.
They have global facilities. They have transactions in foreign
currencies. They operate under different business ethics in
different parts of the world. So it is very easy, if there is a
desire to misrepresent, to obscure and hide. So it is a very
difficult task to identify and assess blame.
So it makes sense that your subcommittee and the Congress
and the Government should be focusing on how to have maximum
emphasis on deterring the crime before it is committed rather
than trying to penetrate this very difficult system.
The question is how can you use criminal sanctions to deter
the wrongdoing. How do you establish a system of punishment and
a belief not only that a crime will be detected, but also that
there will be swift and effective punishment? How do you make
the punishment fit the crime?
In the white collar area, and certainly in the corporate
area, there probably has been a sense that detection was not
likely and that if detection were made that the threat of
punishment was limited and might even be nominal.
So there is going to be success in creating deterrence
through criminal sanctions only if there is a belief by
potential white collar criminals that there is a high
likelihood of detection and a high probability that, if
detected, there will be serious punishment.
The most powerful deterrent in this field, as in many, is
jail time. That is a threat that people understand. For
business criminals, money is also important, but there is
nothing that is more effective than the expectation of spending
time in prison.
There has been some progress recently in strengthening the
criminal sanctions for white collar crimes, and the Biden-Hatch
amendment that you have proposed goes further in trying to
accomplish that to strengthen and to introduce an element of
accountability through requiring the certification of corporate
reports.
With respect to the criminal penalties that have been
proposed in the amendment, I find them to be rather rational
and appropriate. They seem to be harmonizing, and as you have
pointed out, they are trying to make the criminal sanctions for
white collar crimes comparable to the sanctions that would
apply to other kinds of crime. In that respect, I think the
amendment is right on target.
The other element of the amendment, the concept of
requiring certification by the senior officers of the financial
statements, is one that is being widely discussed. It is clear
from what has happened that there may have been a breakdown in
accountability for corporate misrepresentation and wrongdoing.
While I would have thought that deliberately
misrepresenting financial statements would already be a
criminal offense, the amendment makes it explicitly so, and
therefore strengthens and focuses clearly on this element of
white collar crime. The number of meltdowns makes it clear that
accountability needs to be in place, and the idea of getting
these certificates is one way to get the hook on for
accountability and to assign specific responsibility with a
serious sanction for violation.
The proposal is logical in that sense, but as I understand
it, it recognizes that senior officers--CEOs, CFOs, chairmen--
cannot personally audit the books of a complex company. There
is no way they can do that. Thousands and thousands of hours
are spent auditing a complex company.
So one would expect that the intent of this particular
requirement would be that these officers exercise due
diligence, that they make proper investigation, they hire
honest people, they supervise them properly, and they involve
themselves in making sure that procedures are in place to
assure that the statements are correct. And I assume that is
the context in which this is presented. In that sense, I
believe that the proposal will be a positive contribution to
increasing the deterrent effect of the criminal justice system
on these misbehaviors.
A couple of comments I would make, however. One is that the
amendment specifically calls out three officers or their
equivalent. There are many companies that have chairmen who are
non-executive. My personal experience is that non-executive
chairmen do not have the time or the responsibility to have the
intimate knowledge of a company that a full-time executive
would have.
It would seem to me you might want to limit this to people
who are really full-time executives--the CEO, obviously; the
CFO, obviously. If the chairman is, in fact, a full-time
officer, yes, but that element might be reconsidered.
Also, I would imagine, as you pointed out, that in the
criminal system what is needed is to be sure that we do not
make it criminal to have inadvertent error, so that it would be
a case where criminality here would relate to deliberate or
intentional or knowing misrepresentation, which I believe
should already be a crime. But it is better if this is spelled
out very specifically.
When it comes to sanctions, I believe that no amount of
potential criminal punishment will be effective as a deterrent
if the perpetrator believes that punishment will never be
applied. Therefore, one might conclude has to say that having
sanctions is not enough. One must have the will, the
commitment, and the resources to prosecute and to convict.
Without that, the deterrent effect is not there.
I want to point out a lesson from history that I think
demonstrates this. It seemed to me that early in my business
career that there was somewhat a loose attitude toward
enforcement of the antitrust laws, until some senior executives
of a major company were sent to jail. As soon as they were sent
to jail, the whole attitude about enforcing antitrust laws
changed.
In other words, it wasn't the law that changed. What
changed was the enforcement, and when the enforcement changed
so that executives understood that they could end up in prison,
suddenly all corporations adopted antitrust compliance into
their ethics standards. They started holding seminars. Their
attorneys were required to educate their people.
So it is important here not only to see that we have
sanctions, but to see that the law enforcement agencies, the
SEC and the Department of Justice, have the resources to follow
up and enforce. The impression has been that the SEC has been
underfunded in this, and it is encouraging to see that Congress
is addressing this and is beginning to increase the human and
financial resources that are needed to follow up and to create
a real belief that the sanctions are not simply passive, but
they are ones that will be enforced and will create a threat to
the personal well-being of the perpetrator.
Let me conclude just briefly by saying that in this
particular kind of crisis we should not forget that, as bad as
the situation is, the great majority of American businesses are
managed responsibly and they contribute enormously to the
economic system that has created in the United States the most
prosperous society in the history of the world.
As we look to increase sanctions and increase enforcement,
we must not also add to the discouragement of the business
community to attract talent and to attract the skills they need
to continue this process. We must not create a situation in
which being a business executive is so onerous that only people
who are incompetent or inclined to criminality are the ones who
are interested.
We must continue to create a system that has flexibility
and resilience. There must be responsible accounting,
obviously. The safeguards, the supervision, and everything must
be in place to create deterrents and to enforce them. But we
should also continue to encourage the enormous innovation and
creativity of our system.
Even the number of meltdowns we have had in this particular
series of events has not been able to stop the dynamics of our
economy. Isn't that remarkable? With all of these things that
we read about, the billions of dollars involved, the economy is
performing well. The economy is growing. Profits will rise. The
stock market will recover. We have amazing resilience and we
shouldn't talk ourselves into bad times because a few people
have upset the apple cart.
We must remember that when the market was rising, there was
the view that the wealth effect helped the economy. I hope we
don't talk ourselves into a situation where a declining stock
market, because of reasons unrelated to the real economy, has a
poverty effect which depresses the economy. That would be
unfortunate, because this country is really a remarkable
example of what can happen with the right standards and the
right atmosphere to release human talent.
This country is not broken. So as amendments, are enacted
it will be prudent to make sure that the amendments where they
are needed and where will be effective to deter and sanction
the criminal actions of a relative few people. While the
actions of those few people may have been severe, the great
majority continue to be responsible and positive.
[The prepared statement of Mr. Miller appears as a
submission for the record.]
Chairman Biden. Thank you very much, Mr. Secretary.
Mr. Hills?
STATEMENT OF RODERICK M. HILLS, FORMER CHAIRMAN OF THE
SECURITIES AND EXCHANGE COMMISSION, AND CHAIRMAN, HILLS
ENTERPRISES LIMITED, WASHINGTON, D.C.
Mr. Hills. Mr. Chairman, in this turmoil that we have
surrounding misbehavior by corporations, I hope we won't lose
sight of the fact that in the past 26 years enormous progress
has been made in corporate governance.
In 1976, because some 400 American companies had been found
to have bribed foreign officials, the SEC persuaded the New
York Stock Exchange to create independent audit committees,
required the accountants to have higher auditing standards, and
required corporations to have effective internal controls.
Since that time, directors' colleges, conferences, and
commissions have been trying to beat the principles of
corporate governance into the heads of directors, accountants,
and lawyers, but we have some fundamental weaknesses.
First, the system is 70 years old. It is creaky. It needs a
major overhaul. Experience tells me that everything 70 years
old gets a little creaky. Audit partners have not been able,
and probably will not be able under this system to resist
management pressures. And, third, the audit committees just
have not been exercising the authority that was given them in
1976.
The system: The external audit has become a commodity.
Chief executive officers see no intrinsic value in it.
Accountants compete for the work on cost, not on quality. The
system has too many rules. This maze of rules is an incentive
to innovative minds to create these complex systems that wind
their way through the maze, satisfying the rules but
frustrating the purposes of our securities laws.
The auditors are becoming rule-checkers. If the rules seem
satisfied to them, they will approve the financial statement
even though common-sense judgment would have directed them to
do otherwise. The quality and the number of people entering the
accounting profession has deteriorated substantially in the
past 25 years.
The audit committees were created to protect the
independence of the audit and of the auditors, but they are not
doing that. They are not asking the auditors if there is a
better way to present the financial statements. They are not
participating meaningfully in the selection of auditors or in
the fee negotiations, and they are not making any effort for an
intensive, independently-assisted evaluation of the work of the
auditors. The auditors understand that. As a result, they don't
expect the audit committees to protect them from management.
The remedies: There is no secret about where we want to go.
Professor Weil of Chicago said, I want accountants to use
fundamental concepts in choosing accounting methods. That is
the European-English system. Why aren't we there? It is because
the auditors are afraid of having their broad judgment tested
in juries across the country and so they ask for specific rules
to protect them from that type of litigation.
The SEC could provide a veneer of protection for them, but
I must say that it would be unwise for them to do so until
there is an oversight body capable of monitoring the
profession. The oversight body in the Senate bill is on the
right track. Its efficacy is going to depend upon its ability
to work harmoniously with the SEC. I trust and hope that the
conference report today will have clarified the ability to
establish that relationship in a workable fashion.
The body could be given further authority. It could be
empowered to do more preventative work to find the bad
accounting before it hurts the shareholders. A model could very
well be the work of the bank examiners for the Federal Reserve
Board, for the Comptroller of the Currency, or even the work
the SEC does with broker-dealers.
The prescriptions of the Senate bill, I think, also deserve
support. I hope, again, in the conference committee the audit
committees, with effective findings of fact, will be able to
give a little more flexibility to some consulting work and a
little more flexibility to do some internal audit work from the
external auditors.
The audit committees can fix themselves. They may need a
push from the SEC or from Congress to do so, but they can and
must take charge of the audit. They must, and can, confer the
independence that is needed for the auditors. The audit
partners are not going to yield to management pressure if they
feel they can be protected, and the point I am trying to make
is they don't feel that way today.
I do believe that the strengthening of the laws,
represented by the White Collar Penalty Enforcement Act, is
positive. It will have a salutary effect, and as Secretary
Miller has said, the real problem is the difficulty of seeking
convictions in financial fraud cases.
The task force created between the Justice Department and
the SEC can be effective. Joint units working with the SEC at
U.S. Attorneys' offices, particularly here in Washington, D.C.,
can enforce each other's ability for their own enforcement
responsibilities. The Justice Department can also at this
particular time provide assistance to the SEC because it is
going to take the Commission a long time to train the people
they need for the responsibilities they should exercise.
The biggest hope, Mr. Chairman, for more effective
enforcement of crime will be the budget increases of the SEC
and the oversight body that will come out of this. Working with
the Justice Department, they can move faster to deal with bad
accounting. And by moving faster, they can preserve evidence
that is otherwise lost, evidence that can be used later in
enforcement proceedings where it is appropriate.
Finally, as we acknowledge the deficiencies in the system
and begin to correct them with legislation and by practice, it
seems to me we must also acknowledge the importance of the
accounting profession to the global economy and to our society.
The profession is in trouble not just because of carelessness.
It does not have the quality of people and the responsibility
it needs, and so I suggest that it is important to not
needlessly harm the profession as we go forward in the task of
remedying this system.
I appreciate the opportunity to present those views.
[The prepared statement of Mr. Hills appears as a
submission for the record.]
Chairman Biden. Thank you very much.
Mr. Doty?
STATEMENT OF JAMES R. DOTY, FORMER GENERAL COUNSEL, SECURITIES
AND EXCHANGE COMMISSION, AND PARTNER, BAKER BOTTS, LLP,
WASHINGTON, D.C.
Mr. Doty. Mr. Chairman, I appreciate the opportunity to
appear in this historic series of hearings on white collar
crime and the relationship to the current economic and
corporate crisis we face.
Sitting here thinking about your remarks on the Yale Law
School, I have to tell you that when I was there one of the
professors who was highly regarded said the trouble with this
place is that you, meaning the students, are all young fogies,
and we, meaning the faculty, are all old turks, aging turks. So
I hope I can give you some testimony today that will at least
not be either an old fogy or a young turk.
Your deterrence issue is timely. The current crisis has
been cast against this backdrop of September 11, the end of an
historic bull market, the pressures on management to meet
short-term targets that are intensified by stock option and
stock bonus incentives, and the techniques that consultants
have developed to try to boost short-term values. Those are all
circumstances that are getting properly the attention of
lawmakers and regulators.
But what puts the deterrence issue in the forefront is not
just the magnitude of the market loss, but the apparent fact
that in a few of the most conspicuous cases top management
acted either with the belief that they had the informed
approval of their boards and their audit committees or without
any serious concern that they would be called to account.
I think that in common with the themes of my fellow
panelists, deterrence here depends upon two factors. One is
increasing the risk of detection of fraud; second, enhancing
the governance mechanisms that act as a guard rail and keep
management well clear of fraud.
In corporate America, as I think my colleagues have said,
we don't want to have management that is close to the border of
fraud. We don't want the perception that our people operate
close to or in fear of criminal prosecution, but well short of
that guard rail.
As a practicing securities lawyer who advises boards and
committees, and as a former General Counsel of the SEC, I share
your concern that corporate America not only act responsibly,
but clearly be seen to act responsibly, and that involves
changes, I think, in our system of corporate governance that
are now underway.
I would like to touch on some of the aspects of the
criminal side and then some of the governance areas that I
think relate to what you are doing in this committee.
First, the hearing, as I understand it, is concerned in
part, among other things, with the question of whether the U.S.
Securities and Exchange Commission should have criminal
enforcement powers. That is a real issue, whether Congress
should enlarge the SEC's statutory mandate to include the
responsibility of seeking indictments and prosecuting criminal
cases.
We know that violations of the Federal securities laws
which are committed with the requisite intent are now criminal,
and indeed the arrest of the Rigas family in the Adelphia
scandal today is evidence of that. the SEC now refers criminal
conduct to the Department of Justice, and I just say we have
observed no reluctance on the part of U.S. Attorneys to pursue
those referrals.
In those cases, the SEC staff officers who have
investigated a civil fraud case are designated as special
assistant U.S. attorneys by judicial order to assist in the
preparation and trial of the criminal case. So that perhaps
leads to the fair question, why not just take the next step and
give the SEC criminal authority? I would like to respectfully
warn against that and suggest reasons why I think the SEC's
authority should stick with the civil and the structure of
civil and criminal demarkation be as it is now.
First, civil trial lawyers really are generally not
competent to try criminal cases, and I think they recognize
that and I think the SEC civil enforcement staff would say it
is true. That means you have to create a separate criminal
trial unit within the SEC, and that would be done at a time
when the agency is experiencing resource constraints. Once
created, that unit may actually impair, I think, the close
cooperation that now exists between the U.S. Attorney and the
SEC, and which Chairman Hills has referred to.
Second, the SEC has functioned well in the past because of
its limited mission. It has been often said that they have a
limited mandate; that is, to assure transparency in the markets
and preserve market integrity through rulemaking, disclosure,
and civil enforcement. If criminal enforcement is added, Mr.
Chairman, I think there is a danger of mission creep. I think
the question then arises as to whether or not violations of the
CFTC and the FTC are also part of that mission.
Finally--and this is, I think, of great concern to the bar
that is on the good side of this exercise of trying to obtain
compliance--I think the civil enforcement process encourages
settlement and, with that, administrative and judicial economy.
I think that facility of settlement is something which past
general counsels other than myself have noted, and would be
impaired if the agency had criminal enforcement powers.
So it seems to me the choice for us is to increase the risk
of detection of fraud by those committing it by giving greater
resources to the agency for its detection function. I think
given the choice between having adequate staff to properly
review filings, review accounting policies and practices,
investigate initiatives to cover fraud, all in the early stages
which leads to early detection, or, on the other hand,
launching a criminal division within the agency, I think the
agency would prefer to have those resources and, as Chairman
Hills' comments indicate, go after fraud in the early stages
and be ahead of the wave, ahead of the curve, on where
fraudulent practices are beginning to creep into accounting.
Now, does the threshold for criminal liability need to be
lowered? I think you have heard persuasive arguments as to why
the penalties need to be real. I believe that is true, but I
would not tinker with the threshold for criminal liability
because we have to remember it is an economy that we are
regulating.
This conduct that we are regulating is often not malum in
se. It is conduct which, if it strays far enough from the
complex rules that we expect to be obeyed, can become criminal.
The complexity of the rules can be part of the problem, but we
need to stick with specific intent. And you, I think, reflected
this in your introductory remarks to us. The object is to keep
corporate managers careful, not render them paralytic.
The standards of criminal liability, I think, also are
fairly well hard-wired into our culture. I think judges,
lawyers, and regulators understand what specific intent is, and
I think we understand what separates it from negligence or even
from recklessness that should involve civil liability.
But none of that implies that we have to rely on just the
moral imperative in the mind of the executive, and I would like
to touch with you briefly on what I think the three changes are
that are occurring in our corporate life that relate to the
work of the committee, relate to what you have heard today, and
I think are going to transform governance.
First, there is a recognition that corporate accountability
and responsibility starts with individual accountability. Just
as tone from the top communicates corporate values and creates
corporate culture, accountability starts as an individual
matter from the top. We are already seeing the effects on
accountability of the SEC's June 27 order requiring written
statements under oath certifying by chief executive officers as
to the material completeness of financial statements. I would
say, Mr. Chairman, from where I sit there are few expressions
of outrage or surprise. You don't have people saying why are
they doing this. I think corporate America understands why this
must be done.
There are some questions about authority issues, whether
the Commission has authority to continue this as a practice.
And that is in your lap and I think you and your colleagues are
attending to that. But to pick up with where Mr. Miller was
leading, I think processes are in effect. Processes to comply
with these certification requirements and to assure accuracy
are well along.
Elaborate processes are communicated down from the top.
Companies are getting ready on the 15th of August to make the
first round of certifications, and I can assure you that it has
not gone unnoticed by CFOs and CEOs that these statements, as
sworn, are subject to penalties of perjury.
Chairman Biden. Mr. Johnson in 18th century England said
there is nothing to focus one's attention like a hanging.
And you remember, Mr. Hills, when we went through that. I
was here at the time we dealt with the issue of bribery of
foreign governments, and I remember how Irv Shapiro of the
DuPont Company got positively involved, and it really did
change the focus a little bit.
I didn't mean to interrupt you.
Mr. Doty. You are right on, and I think corporate America
is ready to do this. It is getting ready to do it and to show
that they have done it right, because they have the overriding
interest that Mr. Miller referred to in having this confidence
restored.
The second point is I think the SEC is going to get the
administrative authority to bar offenders from serving as
officers and directors. I would say this is as great a threat
to the reputations, the careers, and the livelihoods of
professional managers as the threat of criminal prosecution.
Incarceration carries a different threat which Mr. Miller
has pointed to, but I do believe that because this bar will be
enforced administratively and without the independent
determination of an Article III judge, as has heretofore been
the case, this is being taken very seriously. I think it may be
the greatest single deterrent weapon in the SEC's arsenal going
forward.
Third, just to pick up on what Chairman Hills is saying, I
think independence from professional management in the form of
independent boards, independent audit committees, and
independent oversight of the accounting profession is
essential.
There are some good things going on that I would point out.
The New York Stock Exchange and the NASDAQ rules are going in
the right direction. The New York Stock Exchange is going to
give the audit committee sole responsibility for hiring and
firing the independent auditor and the right to approve the
rendering of any non-audit services. These rules will have an
effect on the way audit committees function.
Audit committees read the paper. They are like the Supreme
Court, and I think the current climate has invigorated audit
committees. The passivity and the cozy relationship that Mr.
Hills and others have spoken out against over the years, I
think, is coming to an end. Along with the real powers they are
getting as an audit committee, I think you can look to see
compensation committees exhibit more activism and more real
oversight of boards of directors.
The accounting profession, with the adoption of the
legislation that has been agreed on today, is going to have
either a public accountability board or a public company
accounting oversight board, however you all decide to style it,
but it will change the relationship of the auditing community
to regulation. Public accountancy will be a regulated
profession, with the auditing practices, the independence, and
the standards of each firm subject to annual review by a body
with the independent authority to sanction. The result of all
of that is the recognition of the responsibilities they have is
going to make a big difference.
My testimony is not, Mr. Chairman, that all is well with
corporate America, or that criminal sanctions don't have a part
to play in ensuring responsibility. On the other hand, I do
agree with Chairman Greenspan that we are going to be using
this corporate model that we have for some time. I don't see us
going to a European model. It would not be good for America.
It would be a good exit from this current crisis if our
corporate model and regulatory regime, which have underpinned
the most transparent markets in the world, were once again seen
abroad and at home in that favorable light. I think with the
retrospective of, say, a couple of quarters in an annual report
period, let's say mid-May of 2003, the markets may well have
concluded that we once again have the most reliable periodic
reports and financial statements in the world.
[The prepared statement of Mr. Doty appears as a submission
for the record.]
Chairman Biden. I thank you all for your statements. With
your permission, I have some questions.
Let me begin by reiterating what most people but the
editorial board of the Wall Street Journal seem to fail to
understand. As chairman of the full committee and chairman of
this subcommittee, I do not believe the answer to our problems
lies in criminal sanctions, but I am going to make a relatively
broad statement and ask you each to comment on it, if you
would.
If you want to know what a society values and what price
and value they place upon a transgression against what they
value, you have to look at their criminal code. Some societies
do not, for example, have penalties that are particularly
strong for crimes against females. Some do. Some do not hold
crimes against property much higher than crimes against
persons.
In our society, we have made some very basic judgments
based on our English jurisprudential systems that have been
relatively consistent. Having been the guy who has been the
author--and it is not hyperbole; I mean it literally--of every
major piece of crime legislation that has come out of this
Congress since 1982, I believe that we have operated in part up
to now on the premise that the threat of embarrassment and the
threat of exposure in and of itself was such a deterrent to
most business men and women because of the economic and social
strata from which they come that it acted as a greater
deterrent than it might in other sectors of society. So there
was less need to have penalties that resulted in criminal time
being done in a Federal or a State prison.
The second thing that operates--and I know you all know
this--is it is much harder to make a complex white collar crime
case as a prosecutor than it is to make a criminal case, even
if the criminal case is murder or something of consequence, not
some petty-ante crime. For the reasons that Secretary Miller
talked about, it is just harder to do. It is easier to hide,
and so on.
So there has been, I would say to Mr. Hills, in the
testimony we had in our first two hearings evidence that there
are many fewer referrals from the SEC to the Justice Department
over the last decade or more. And this is not a Democrat/
Republic thing; I am not getting into any of that.
In speaking to members of the Criminal Division of the
Justice Department and U.S. Attorneys, there is not a
reluctance to take the case that is clear, but you would much
rather take cases that are more celebrated and less tortuous to
make. It is human nature, I think.
So for all those reasons, all I am attempting to do is try
to bring our criminal justice system and the penalties related
to white collar crime in line with a slightly different
measure, and the measure is what we do in other crimes: what is
the degree of damage which they do to society and to
individuals?
If a corporate executive knowingly and criminally violates
the laws that protect Americans' pensions, ERISA, under the law
it is only a misdemeanor. You could cause someone to lose their
pension that was $1, $2, $3 million, or 50 people where the
pensions added up to $500 million, or 1,000 people, and you
could only go to jail for up to one year.
If you steal my car in my driveway in Delaware, which is
only a couple miles from the Pennsylvania border, and drive it
across the Pennsylvania line, 10 years from the Sentencing
Commission guidelines. So there is a real disparity here in
terms of the value of the thing taken and the punishment that
results.
Also--and I will end my little exposition here and the
rationale behind our criminal law--it undercuts respect for the
law when average Americans see and know the penalties people
pay for crimes that have much less consequence in their
neighborhood, their society, the well-being of their friends
and neighbors.
As you pointed out, Mr. Secretary, assuming that even a
significant portion of it was a consequence of criminal fraud,
you are talking about the loss of value, as you point out, if
you add it all up, exceeds the GDP of any other country. It is
kind of hard for any criminal, including going into Fort Knox,
to have that kind of impact.
So I want to make it clear that I am not on a populist
crusade here. I might say that I think the Congress has acted
pretty responsibly so far, in light of, by the way, what our
constituents want us to do. Our constituents want a dead dog
delivered to somebody's doorstep. I am serious.
I guess you do have an idea. Our constituents out there--
and it doesn't matter whether they are upper- or lower-income,
middle-income; they want somebody to pay because they are
angry. In some cases, many of my constituents, from their
perspective, and they may be literally correct, have had their
lives stolen from them in the sense that if you are 56 years
old and your 401(k) loses 70 percent of its value or is wiped
out, you don't have a whole lot of time to make that up.
So, anyway, that is the context in which I am going to ask
you some of these questions. So I really am not looking for
draconian measures and I understand the limitations. Chairman
Greenspan was pretty straightforward about the notion that
personal accountability focuses attention. Now, as the old joke
goes, you have handled things way above my pay grade. You have
been significant businessmen and CEOs. You have had significant
positions in the Government.
Is there a correlation, in your view, between the amount of
responsibility and accountability to which a corporate official
and/or board member is held and the due diligence that they are
likely to exercise in the performance of their duties?
I am not saying that I believe business men and women per
se are bad guys. I am not saying that at all, but is there a
correlation, and at what point do we impose a potential
sanction where it begins to dissuade people from either being
innovative or dissuades them from participation on a board?
Let me conclude my little thing by saying this. When you go
to school and you are not a business major and you are a lawyer
who is not focusing on corporate questions, or you are an
undergraduate who is not a business major, you learn the basic
sort of block structure of corporate America, corporations, and
the notion of fiduciary responsibility, who reports to whom,
who has what responsibility, where the stockholders stand,
where the hired hands, including the CEO, are, what the
relationship of the board is to the operating officers.
Technically, the board hires and fires those folks.
So in the context of responsibility, can you talk to me a
little bit about how, as you were saying, Mr. Hills, things
have sort of changed in the last 10, 15 years? I mean, I think
most Americans thought that if you had an audit committee on
the board, they did something other than, when the audit was
presented by whomever, just stamp it, that they were supposed
to have some function other than merely saying this is okay It
is has been submitted a good auditing outfit, a good accounting
firm, and it is all right.
What is the function of an audit committee? What was it
envisioned to be? What has it become? What should it be?
Mr. Hills. If I may, having been present at the creation,
the notion was that the failure to have an independent audit
committee was a material weakness in the controls of the
company.
Chairman Biden. I know what you mean, but for the record
define what you mean by independent audit committee.
Mr. Hills. Traditionally, I must say we have gotten into
the habit of using only one standard, objective independence.
To be a little colloquial about it, it means how many times did
you play golf with the chief executive officer. You know, are
you a cousin, do you get paid, do you have consulting fees?
Objective independence is very easy to find, although many
boards haven't done it. But objective independence simply means
you have no other business relationships or social
relationships that would interfere with independent judgment.
It is way not near enough to have objective independence. I
would say it is a three-dimensional form. The second dimension
is you have to independently decide what you need to know. You
can't just sit there and take what is handed to you. You need
to know, for example, that you need a management letter every
year, the management letter, not one that is concocted for the
audit committee.
It is now public that in Waste Management for five years
the audit committee did not get a management letter and didn't
ask for it. Yet, the management letter that went to the company
had 12 items that the company absolutely had to change to have
good accounts and they didn't change it for five years. Nobody
asked for that because they did not objectively decide what
they should see.
The third dimension of independence which is, in my
judgment, as important as the other two, maybe more so, is you
will not have an independent auditor unless you confer
independence on them. You have got to grab them by the neck and
say you work for us, you don't work for the company, you are
going to get fired the first time we hear that you have given
something to the company that you haven't told us about; we
want the letters you have sent management, not the ones you
frame for us. So independence has those three dimensions. If
you get those three dimensions, you have a good audit
committee.
Chairman Biden. Now, gentlemen, what is the responsibility
of the board in this regard? In other words, is the board's
responsibility to insist that it be independent?
One of the arguments being debated right now in the
conference--and you raised it, Secretary Miller, and I
understand the argument and I disagree with it. One of the
differences, as Mr. Doty knows, being the lawyer who advises
clients on these issues, is if the law changes as Hatch and I
wrote it, it is going to require not just a signature, but a
certification to the SEC once every quarter that what we are
submitting to you is accurate. If you knowingly or willfully
violate that and say you knowingly supply false information or
you are involved in concocting that false information, then you
are criminally liable.
Now, no one seems to argue with me that a CEO and a CFO
should be held accountable because they do the day-to-day
management. But people have made the argument to me that about
10 or 20 percent of the chairmen of the board are neither CEO
or CFO or hold any other operating position within the
corporation. They are doing it part-time, not full-time, and
therefore they shouldn't be held accountable to the same
standard, even though it is ``knowing,'' which I find
interesting, even though it is a criminal standard.
If we don't hold the boards responsible for what on paper
you learn in Business 101 is their function, which is to
oversee the management of the company, then what are we doing
here?
And I don't think this is so black and white. I am prepared
to be shown that I am wrong on this, but I don't know what you
teach them in Business 101. If, in fact, you say this board
here has this responsibility, but if everybody knows they don't
take it seriously and it is not a full-time job and you can't
expect them to really do the job, then why the hell do we have
a board, or why don't we say really what it is?
Yet, we go around and we talk about the board like it has
this function that many of the Fortune 20, 25 CEOs whom I know
and have spoken to--not every one of them by any stretch of the
imagination, but they all basically say to me, well, Joe, you
can't expect these guys to be responsible. That is not their
phrase. They can't be held to the same accountability as we
can.
So how can you have an outfit that oversees and hold it to
a lesser standard than the outfit that operates, when one of
the reasons you have the outfit that oversees is allegedly to
protect the stockholders and the public from malfeasance or
maintain good business practices on the part of the operating
officers?
Talk with me about that a minute.
Mr. Miller. Well, Mr. Chairman, I would like to clarify a
little bit. I don't believe there should be a lesser standard.
Under corporate law, as I understand it, the board of directors
is responsible for the management and affairs of the
corporation, period. The officers get their authority by
delegation from the board; so it is the board that is
responsible. I don't disagree.
My point about a chairman who is part-time was not that
there should have a lower standard of accountability fo him. In
fact, if such a chairman falsely signs a statement, he should
go to jail. The question is: does he know enough to sign that
statement, as distinguished from what else he knows? It was not
a question of his being allowed to sign something false. That
would be unacceptable.
I want to go back to your point--and perhaps we can
elucidate on that. I don't know that it would be popular, but
it might be more logical for the chairman of the audit
committee to be signing, who should have spent a lot more time
on reviewing the financial statements than a part-time
chairman. Not every member of the board can be on the audit
committee, and it certainly is true some directors will be
disqualified if only independent directors can be on the audit
committee. So members of the audit committee will have a degree
of knowledge about the financial statements that some other
director won't have.
I think your comments about the purpose of your legislation
and your approach are valuable comments and I just don't want
to pass up an opportunity to say that if we had an ideal world,
the only criminal law we would need is the Golden Rule.
Chairman Biden. Yes, that is true.
Mr. Miller. That is all we need. We know if we are acting
inproperly. We know when we are wrong. We know right and wrong,
but unfortunately we have found that not everyone wants to
adhere to what is right. So the problem in corporate management
has come in waves over the centuries.
Don't forget there was the era of the robber barons, and
don't forget there had to be huge reforms in securities law
which now are basically founded on disclosure, on the theory
that if everybody has the some information, they can act
rational and there will be an efficient market.
There was the time when monopolies arose and damaged the
economy. The response was to enact various antitrust, laws,
including not only anti-monopoly laws, but also anti-price-
fixing laws, and so forth.
In the case that we are talking about now, if, in fact, all
corporate managers treasured their reputation and their social
standing, you wouldn't need these sanctions. Unfortunately, not
all those in corporate managment or in business treasure their
reputations. Criminal syndicates do gain influence over various
activities. Criminal syndicates or equivalents may find their
way into the executive suite.
So you need sanctions not because most corporate manager
don't so care about their families, their reputations, their
standing in the community that they would never will falsify or
misrepresent. Sanctions are needed for the others, the
minority, who will falsify and misrepresent. I am appalled at
the list of those who fall in the latter category.
Chairman Biden. Mr. Doty, you advise a lot of serious
people and one of the things that seems to have--and, again, I
have no pride of authorship in this amendment. If it doesn't
make sense, I am not trying to make the case for the amendment,
really and truly.
I am trying to figure out what the devil happened. There
seems to have been--``meltdown'' may be too pejorative a word,
but there seems to have been a diminution of the sense of
responsibility that board members had over the last decade or
more, not because they are bad. Maybe it is because they
thought everything is so complicated and things run so well and
things are going so fine, all I have to do is show up and get
paid my $50 for the meeting, or my $500,000. It is not because
they were engaging in anything that was wrong.
Mr. Doty. Not bad people. They didn't want bad things to
happen.
Chairman Biden. Yes, but there seems to have been sort of a
morphing of the way in which the board related to management.
Now, I understand it is very popular now, this phrase about the
imperial CEO/chairman of the board doing both, one person
controlling everything, et cetera.
Am I wrong, or has there been a diminution of the sense of
responsibility when someone is asked to be on a board? When you
guys were asked to serve on boards as prominent businessmen 35
years ago, did you have a different sense of responsibility
than if you were asked at the same age, but you were the same
age in 1995 being asked for the first time to serve on a board?
Mr. Miller. I certainly have no different sense today than
I had 40 years ago.
Chairman Biden. I don't mean you personally. Do you
understand what I am trying to get at it? What happened?
Mr. Hills. There is a big difference. Thirty-five years
ago--I want on my first board 34 years ago. You were asked to
go on the board for your resume, not your advice. You got four
crisp $100 bills under your luncheon plate that you didn't have
to show your wife and you went home after a good lunch and you
played golf with the CEO on weekends and retreats. Yes, you
were honest and able, but there was not much expected. The
responsibility has evolved over these years.
I come to the same conclusion as to where we are today, Mr.
Chairman, but I don't think there has been a diminution.
Chairman Biden. I see.
Mr. Hills. I think the fundamental weaknesses have been
there and they show up when you have this burst of a bull
market.
Chairman Biden. I see. That makes sense to me.
Mr. Hills. I think that the responsibility of boards, to
which they can be held accountable more and more every year, is
evolving.
Mr. Miller. My experience is slightly different. Thirty
years ago, I did not serve on a board because of my resume. The
directors I served with took their responsibilities very
seriously. I remember a board I served on where an
environmental issue came up before environmental issues were as
important as now, and the board stepped in with great vigor to
make sure the the company got ahead of the curve and that its
facilities met environmental standards higher than were then
required.
The board of that company initiated the first environmental
audit. Now, this was 35 years ago. The directors were not just
sitting there waiting for their checks and their lunch.
Mr. Hills. I think you are right, but Peter Drucker wrote a
book about General Motors back in the 1930s. General Motors had
the perfect board in the 1930s. It had an independent audit
committee, but, boy, was that the exception.
Mr. Doty. Mr. Chairman, I have got to say the two men on my
right have done a great deal to cast the improvements that we
have seen in board governance over 30 years. I can't speak for
30 years. I can speak for 25 or 20 or so, and I would say I
think it has gotten better.
I see directors who are hard-working people. I see
directors who have a heightened sense of what they have to do.
I see directors who are concerned and embarrassed by what they
see going in on some of these front-page stories. I see
directors resigning from boards because they think they belong
to too many boards.
This is one of the things that happened. People began to
collect boards, and the man on my right has never made that
mistake. He has moved in and made a real contribution to the
boards he has sat on and seen it as his duty to change
something for the better. That is an attitude which I think is
becoming more common among directors.
One other point I would make is it has become more
complicated. The financial instruments have become more
complicated. The accounting became more complicated. The SEC's
chief accountant, with great freshness of candor, says, look,
the rules are too complicated and at times they tempt auditors
into creating complex tax schemes.
So I think there is a combination of factors, plus the fact
that I do think when times are good, people tend to get a
little lax, and that is what Mr. Hills, I think, is referring
to.
Chairman Biden. Let me ask you one other question. The
strongest argument for any heightened accountability for a
board member, let alone the chairman, is the world is a lot
more complicated, number one, and I don't disagree with that.
Mr. Doty. And you have seen specialization, Mr. Chairman;
as a result of that, specialization within the board.
Chairman Biden. The second reason offered is if there is a
potential criminal sanction, because things have become so
complicated it will have such a chilling effect on good women
and good men being willing to serve on boards that what we will
do is we will have the reverse impact we are seeking.
We are going to get people who, for either the prestige or
the $100 bill under the plate, figuratively speaking, will take
the job. You are not going to get serious people who have other
enterprises that they have to deal with and take care of
participating.
Now, I have great respect for all three of you. What do you
think, both from your professional and your personal
observation, would be the chilling effect of a criminal
standard? Is that enough to keep an otherwise competent person
from being willing to become a chairman of a board? That is my
question.
Mr. Doty. Well, the SEC has long recognized that the way in
which you evaluate management directors' conduct and the way in
which you evaluate independent directors' conduct, outside
directors, is quite different. The standard on the securities
laws is the same. Scienter, recklessness--all of those
standards apply to you, whether you are an independent
director, a lawyer, an accountant, or a management member.
But the test is in whether Congress makes it clear in
adopting this legislation that it intends not to have a
chilling effect, that it seeks to have the best people join
boards, and that it really is not looking for targets in the
board room, but instead it wants to ensure that directors do
what Justice Douglas said they should do, that they direct,
that they work hard, that they not have too many boards, that
they take their duties seriously, and that they not be willing
to simply rely without good reasons for reliance.
Chairman Biden. My problem here is I don't know how, in a
principled sense, I introduce legislation, which I did,
requiring certification from a CEO and certification from a
chief financial officer and the liability incurred as a
consequence of that legislation only if there is a knowing or
willful conduct to lie, to misstate--how you do that and then
not hold the chairman of the board responsible to the same
standard which requires a high burden of proof beyond a
reasonable doubt that you actually knowingly signed something
you knew to be false, not that you should have known.
Mr. Doty. Well, I think anyone who knowingly signs
something they know to be false risks criminal prosecution now.
But you do have to recognize, I think, the difference between
management which controls the process whereby they can
determine the accuracy of the financial information and the
board of directors which traditionally has not. They don't have
the human resources at their beck and call that management has.
That has been a fairly bright line.
If, as the panel is saying, audit committees are more
active in hiring and firing the auditors and they are more
involved in the actual preparation of the financial statements,
you will see heightened responsibility and accountability among
audit committee members and it will be a difficult question as
to whether one serves on an audit committee. But responsibility
and accountability and sanctions should follow actual capacity,
ability, to affect the results and control of the resources. It
shouldn't just go with status.
Mr. Miller. Mr. Chairman, put yourself in the position of
being a non-executive chairman of a company for a moment and
realize what Jim has just said about not controlling the
process, not controlling the people. You are asked to sign a
statement which reads like an opinion of an auditing firm,
reads that the statement fairly presents the financial
condition.
I think if you were required to do sign, and you did, and
you knew of nothing wrong, that would be fine. Your hesitancy
might be, ``I don't like to sign something when I have not been
able to go through a due diligence process on my own to
ascertain that seven layers down they aren't doing something I
don't know about because I can't see that at the level of
supervision of the board''. If any officer signs falsely, he
should be accountable. Is it fair to ask non-employee to sign?
If it is perceived to be unfair, the office of non-executive
chairman will disappear.
Chairman Biden. As Tip O'Neill said, all politics is local.
All of this gets personal in terms of how we view ourselves in
that situation. I am a United States Senator. I am required
every year to sign off on rules that I vote for that hold me
criminally liable if I make a mistake.
I am required to sign off on documentation of how much
money this committee spends. I don't have any idea. I don't
follow it. And the budgets aren't like the budgets of a
corporation, but they are several million dollars. I am
required to sign off on every expense. If I, as chairman of the
Foreign Relations Committee, send someone to Afghanistan, I am
required to sign off on that.
It is a higher standard than criminal, than ``knowing,''
and I find myself not easy sometimes about signing those things
because I wonder if I don't have the right guy doing this, I
haven't spent the 40, 50, 60, 70 hours compiling this for the
year. The public expects me to be held responsible as a Senator
who is one of 535 people who can affect their lives, and if I
screw up on that it may cost the taxpayers a little bit of
money--in terms of a $2 trillion budget, a minuscule amount of
money.
Yet, if a chairman of a board or a CEO of a major
corporation, where when they screw it up it may cause people
tens of billions of dollars--I don't know. I guess part of what
is at stake--and I will end with this--part of what is at stake
is the first guys that want to hold everybody responsible are
the business community. They want to hold every car thief
responsible and hang them by their heels. They want to make
sure that every welfare mother cheat gets nailed. They want to
make sure that every politician who does anything wrong--and I
agree with them--should be held accountable.
And all of a sudden it comes to a place that affects the
well-being and security of may children and my family as much
as anything that anybody does, other than the President of the
United States, and people are saying, wait a minute, you have
got to understand this is a complicated job.
You are not saying that, I know, but I am saying that is
the dilemma I am grappling with, without trying to turn this
into, as I said, any sort of a semi-populist initiative to go
out and hold people accountable when they shouldn't be.
Mr. Hills. What you can do and what the SEC can do is
define more sharply the responsibilities of these people who
should be held responsible. After 26 years, the duties of the
audit committee are just beginning to evolve.
Chairman Biden. I see.
Mr. Hills. The Enron case won't happen again. The Waste
Management case won't happen again. The audit committees won't
let that happen. The compensation committee chairman will
sooner or later understand that if he doesn't get independent
advice on compensation, he is going to be responsible. If he
takes advice only from the consultant hired by the management,
he is going to be responsible.
If the company continues to hire the auditors and if the
auditors continue to work for the company, the board will never
be well-informed. If the audit committee asserts its
responsibility--it is not easy; you have got to sort of take
them by the neck and shake them a little bit--then you have all
the eyes and ears you need to be responsible for the company.
If you have got 2 or 300 auditors looking at the operations
and they come to you and say, wow, you know, that depreciation
schedule they have on that garbage collection down in Florida,
it doesn't look to me like those trucks last that long, and you
ignore that--if you get a letter from a whistleblower and you
pass it back to management and aren't interested in the result,
responsibility is evolving. It is there, it will come.
Chairman Biden. With your permission--and I have trespassed
on your time a lot already--I have about four or five questions
I would like to submit to each of you rather than keep you here
for another hour-and-a-half. Maybe you would be willing to, in
due course, respond for the record. I will not overburden you,
I promise you. It is not a tome, it is not a deposition. It is
relatively small.
I would also ask unanimous consent that the statement of
Senator Hatch be submitted for the record, and Senator
Grassley, at the beginning of the hearing after my opening
statement.
As I said, with your permission, I would like to be able to
submit to you some questions in writing, mainly to save you the
time, but let me conclude with one generic question.
You know that old expression, the wish is the father of the
thought, or whatever it is. I am mildly optimistic, and I don't
quite know why, that this--maybe I do know why, because I have
watched my friends in the business community and how outraged
they are about what is happening, how many driveby shootings
there are. They are getting clipped and killed for having done
nothing wrong, but just being part of a corporate establishment
where some bad actors have been engaged in serious, serious
malfeasance.
What do you think is going to happen on August 15? Do you
think we are going to find, of the 17,000, I guess it is,
American corporations that you are going to have 15,000 of them
coming forward fly-specking their statements and all of a
sudden we are going to find we are further in the hole than we
were relative to values? Do you think these scandals are going
to be enough to have self-effectuating house-cleaning? What do
you think is going to happen, guys?
Mr. Miller. I think you have good reason to be optimistic
because while the impact has been great, the number of
companies that are responsible and want to be responsible is
overwhelming. You can rest assured that in executive suites
today, regardless of what legislation comes out, they are
already hard at work figuring out how to protect their company
from any kinds of shortcomings that have shown up in these
other cases. So there is already a prophylactic effect taking
place that will be pervasive.
Also, you have seen a change in attitude about some things
that were sacred cows. I think Warren Buffet is being very
effective in convincing a number of major companies to begin to
account for stock options in a different way. These are reforms
that are now being voluntarily moved along, I think, in
reaction to this in the sense that we have got to get ourselves
in a position where we have the trust and confidence of the
American people. It is in our self-interest.
After all, that Adam Smith viewpoint that the self-interest
will drive is a very, very powerful force in society. I think
the self-interest will drive businessmen to make internal
reforms, with or without legislation, that will improve the
system. I think you have a good reason to be optimistic. You
shouldn't stop the legislation because that reinforces against
those who don't want to play by the rules. We do have the
invasion of toxic interests into even a perfect enterprise
system. But the enterprise system is resilient, it is flexible,
it is self-healing, and it does not like this and it will
change it.
Chairman Biden. Mr. Hills?
Mr. Hills. I think I have seen over the years an evolving
responsibility on boards. I think I am optimistic, but on
August 14 or 15, you are going to have some house-cleaning. It
is natural. Every time you send an audit team out to see a
facility that they haven't seen for six or seven years, they
find stuff, and so it is not an unusual thing. By emphasizing
the need for the certification, they are cleaning the attics
all this year instead of every two or three years. So you will
get some. If the media handles it right, I think that will not
be a serious problem.
Mr. Doty. It will be interesting and the 10(q) will be
worth reading.
Chairman Biden. Well stated. As chairman of the Foreign
Relations Committee, it is amazing how many foreign leaders,
heads of state--well, that is an exaggeration. I have not seen
that many heads of state in the last month, but several heads
of state, foreign ministers, defense ministers, and counterpart
parliamentarians are absolutely perplexed, some of them with a
little bit of glee, a little bit of ``I am glad to see your
problems,'' but them immediately realizing it is their problem
if it is our problem.
You made the analogy to 9/11, Mr. Secretary. They are
making a similar analogy that this is of incredible
consequence. In the globalization of the economy, this has
ripple effects that 35 years ago would not have had nearly the
effects it has--the dollar relative to the euro, the dollar
relative to the yen, the dollar and its strength and the
failure to invest in the United States temporarily. I mean,
this is serious stuff.
Mr. Hills. The chairman may remember Ambassador Tommy Koh,
from Singapore.
Chairman Biden. Yes.
Mr. Hills. A week ago, we were in Singapore convening a
session on corporate governance and significant people from
eight countries came and spent three days in intense
discussions not unlike the one we are having here.
Chairman Biden. Did you discern the same thing that this
concern is deep? I mean, it is not a concern that is confined
to the shores of the United States of America by any stretch of
the imagination.
Mr. Hills. They understand they have a much deeper problem.
Chairman Biden. Well, gentlemen, I can't tell you how much
I appreciate you having given me this much time. As I said, I
promise I will not submit more than four questions to each one
of you. And there is not an urgency in a matter of days, but as
expeditiously as you could respond, I would appreciate it.
It sounds trite, but thank you for your service. You have
rendered great service to this country in the past, and the
fact that you are willing to be here at this subcommittee is
further evidence that you are still in the game and we
appreciate it a bunch. Thank you very much.
We are adjourned.
[Whereupon, at 4:10 p.m., the subcommittee was adjourned.]
[Submissions for the record follow.]
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