The dramatic securities fraud trial of Elizabeth Holmes is front and center in the news. Yet, it is just another episode in the long history of white-collar crime in corporate America. Such crimes can trigger enormous financial and reputational losses for employers, as well as setbacks for investors. Moreover, corporate malfeasance has played a role in recent business downturns such as the Great Recession of 2008-2009.
Holmes was declared guilty on several felony charges on January 3, 2022. But will the verdict have any deterrence effect on white-collar criminals in the future? The past is not comforting. Following the convictions of top executives at Enron, HealthSouth, Tyco, and WorldCom since 2000, other significant white-collar and corporate scandals ensued. During the Obama Administration, virtually no one spent time in prison for the financial shenanigans leading to the Great Recession. More recently, there was an unusually sharp decline in white-collar prosecutions during the Trump Administration.
Consequently, it is fair to ask if the Biden’s Administration’s recently announced white-collar crime initiatives will make much difference in the next few years. Deputy Attorney General Lisa Monaco, speaking at the American Bar Association’s White Collar Crime National Institute on October 28, 2021, announced a Justice Department personnel shift to white-collar crime prosecution. She also outlined various changes in operational criteria for monitoring and prosecuting white-collar crime. For instance, in deferred prosecution agreements, corporations will have to cooperate more closely with more stringent Department of Justice guidelines.
To be sure, more rigorous white-collar crime prosecution efforts following the Trump Administration’s lax efforts should make some difference. But will they matter much? Or is significant individual misbehavior in corporations an inevitable ingrained element of individual human nature and our political and business culture? The field of criminology offers some perspective on these questions.
Among criminologists, there are two main schools of thought about the relative roles of society and individual behavioral characteristics in causing crime. The Chicago School, which was led in the early twentieth century by urban sociologists at the University of Chicago, placed most of the blame for crime on society rather than individuals.
A representative application of the Chicago School approach to white-collar crime is Professor James Coleman’s 1987 article titled “Toward an Integrated Theory of White-Collar Crime”. He emphasized industrial capitalism’s social structure and the culture of competition motivating white-collar criminality. A contemporary version of this theory is that corporate stock options-based compensation can motivate some individuals in businesses to pursue short-sighted, ill-advised, and sometimes illegal behavior.
A recent empirical perspective on Coleman’s hypothesis is Harvard Business School professor Eugene Soltes’ 2016 book titled Why They Do It—Inside the Mind of the White-Collar Criminal. He interviewed almost fifty former executives convicted, or accused, of white-collar crimes. Among his conclusions are that white-collar criminals are not merely driven by excessive greed or hubris, nor do they usually calculate costs and benefits before breaking the law. Instead, Soltes shows that most of the executives who committed crimes made decisions based on their intuitions and gut feelings. The trouble is that gut feelings are often poorly suited for the modern business world, where leaders are increasingly distanced from the consequences of their decisions and the individuals they impact. He also points out that more illegal white-collar activities (e.g., bribing foreign officials, backdating stock options and insider trading) are prosecuted today than 50 years ago.
In contrast to the Chicago School, Nobel Prize Laureate economist Gary Becker, in his classic 1968 “Crime and Punishment—An Economic Approach”, placed more emphasis on criminals responding rationally (i.e., in their self-interest) to probabilities of apprehension and penalties, as measured by sentence length and fines. For instance, criminals’ responsiveness to the length of sentences partly depends on their expected lost incomes if incarcerated. To be sure, not all criminals are rational, but Becker’s theories remain useful for assessing policy options that will influence such a subset of rational criminals.
How can rational behavior models help explain and anticipate white-collar crime trends? Consider the following statistical developments relating to perceptions of apprehension probabilities—a key variable in Becker’s models of criminal behavior.
According to Transactional Records Access Clearinghouse (TRAC) data, white-collar crime prosecutions have been steadily falling over the past 30 years. Per annum prosecutions fell 5.8% during the Clinton Presidency, 1.7% during the George W. Bush Presidency, 4.0% during the Obama Presidency and 31.6% during the Trump Presidency.
It’s difficult to believe that this cumulative 43% in white-collar crime prosecutions represented a similar-sized reduction in white-collar crimes committed. Instead, the decline likely reflected a combination of reduced staffing of white-collar crime prosecutors and changed Justice Department prosecution policies. For instance, former Attorney General William Barr succinctly stated in 2019 the priorities of the Trump-era Department of Justice when he articulated a focus “on violent crime, drugs, immigration, and national security.” In so far as perceptions of prosecution activity affect criminals’ anticipated apprehension probabilities, the marked decrease in prosecutions probably has been a positive contributor to white-collar crime.
Some evidence to support this hypothesis recently has been provided in a March 2021 article by Harvard Business School Assistant Professor Trung Nguyen titled “The Effectiveness of White-Collar Crime Enforcement: Evidence from the War on Terror” in the Journal of Accounting Research. Following the 9/11 terrorist attacks, the FBI shifted financial resources and hundreds of agents toward combatting terrorism. Nguyen related FBI headcount shifts from white-collar crime to counterterrorism in judicial districts to evidence of subsequent white-collar crime incidents in those same districts. Her conclusion: “Overall, the findings suggest that the FBI’s reallocation of resources toward counterterrorism following 9/11 was accompanied by significant increases in wire fraud, opportunistic insider trading, and fraud within financial institutions.”
Another way to examine shifting perceptions of apprehension probabilities comes from Internal Revenue Service (IRS) audits data. Between 2010 and 2018, overall audit rates fell by 47% from 1.11% to 0.59%. For annual incomes over $500,000, audit rates fell by around two-thirds. For instance, for incomes above $10,000,000, the audit rates declined 64% from 18.38% to 6.66%. As of 2017, the IRS had 9,510 auditors—a one-third drop since 2010 and the lowest since the early 1950’s. While there is considerable debate about the size of lost tax revenues due to lower audit risk, there are good reasons to believe that diminishing the risk of being caught increases the amount of tax evasion.
Recently, the Biden administration’s proposals for increasing IRS enforcement capabilities have been met with considerable pushback from Congressional Republicans. And the Congressional Budget Office (CBO) has been skeptical about how much income-tax revenues might rise with more IRS agents.
As noted, the Biden Administration has declared its intention to crack down on white collar crime. Yet, there are reasons to doubt that it will have much success. Skepticism stems partly from the failure of the Obama Administration to jail bankers for illegal activities leading to the financial crisis. Rather, the Obama Justice Department focused on civil settlements with corporations who paid heavy fines.
Other concerns arise from how companies reward success. A 2010 article by Babiak, Neumann and Hare titled “Corporate Psychotherapy: Talking the Walk” in the Behavioral Sciences & the Law publication illuminates this point. The authors studied 203 corporate professionals selected by their companies to participate in management development programs. Individuals’ psychopathy test results were compared with their in-house assessments and performance ratings. Psychopathy was positively associated with in-house ratings of charisma/presentation style, creativity, and good strategic thinking, and negatively associated with ratings of responsibility/performance and being a good team player. Psychopathy, in short, was more strongly associated with style than with substance. These results suggest that successful individuals in corporate America may have personality traits conducive to illegal behavior.
So, what’s the bottom line? Rebuilding enforcement resources can make a difference in battling white-collar crime. Yet despite more intensive white-collar crime law enforcement, such crime always will partly reflect hard-to-change behaviors and norms found within many organizations. Sadly, corporate boards, senior executives and investors cannot let their guard down when it comes to white-collar crime.