CLS Blue Sky Blog

‘Don’t Ask, Don’t Tell’ Corporate Crime

In my most recent article, Don’t Ask, Don’t Tell’ Corporate Crime, I argue that modern large-scale corporate crime is driven and shaped by ‘don’t ask, don’t tell’ incentives.[1] ‘Don’t ask, don’t tell’ enforcement based on disclosure polices what corporations say, rather than what they do. The approach also places large, irrelevant burdens on businesses; fuels corporate crime by insulating middle management from prosecution; and, ironically, allows wrongdoing to incubate for increasingly long periods of time without actually revealing what we need to know. Using the 2015-17 Volkswagen scandal as an illustration, I identify three striking characteristics of growing corporate crime and argue that they are related to our failing ‘don’t ask, don’t tell’ system.

First, we are witnessing a new scale, duration, and coordination of corporate wrongdoing. In the VW case, there were likely hundreds of people coordinating across at least three companies and five different name brands who made the cheating possible in 11 million vehicles worldwide. Litigation alleges that the scheme may have lasted 17 years.

There have now been at least five types of defeat devices discovered in VW cars. Worldwide, the defeat devices are likely responsible for the early deaths of tens of thousands of people from illegal air pollution.

Within industries, the methods of large-scale wrongdoing are echoing and being repeated. Some intra-industry pattern may be the result of competitive pressure, but it may also signal cross-company communication. Within the auto industry, for example, VW and its two suppliers are not alone in being suspected of large-scale emissions cheating. Within a span of 30 months, seven automakers have publicly lowered their fuel-economy ratings, the French government is investigating Renault, and the U.S. government, after issuing previous warnings to Fiat Chrysler about installing defeat-device software, has sued the company. The auto industry is merely one example, and we see many more examples, of large-scale coordinated wrongdoing both within industries and across corporate forms.

Second, the top executives and corporate boards whose responsibility it is to maintain their organizations’ integrity are asserting blindness as to the scope and scale of the abuses. Currently, VW’s largest potential liability is from a set of securities-law cases in Germany alleging that investors lost money on VW shares because the company was too slow to disclose its emissions-cheating problems. VW faces a record $9.2 billion in damages if it admits that its top executives or board knew more about the cheating than what and when they told the public. Also, German prosecutors have re-invigorated their investigation into “whether VW’s top management violated German disclosure laws by not informing shareholders as soon as they became aware of the affair.”

This debate over the liability of top executives and the board, which echoes similar debates in the U.S. and other major jurisdictions, has become a game of who within this small group knew what and when; not an investigation into how the fraud itself started within the company, spread, and grew to cause so much harm. VW now perceives such a threat to its welfare from disclosure-based timing issues that it has threatened to sue its former chairman, Ferdinand Piëch, grandson of Ferdinand Porsche, who designed the VW Beetle. The most contentious issue involves Piëch’s admission that ex-CEO Winterkorn “knew of the diesel fraud as early as February 2015,” which conflicts with Winterkorn’s assertion to the German parliament that “he did not know what a ‘defeat device’ was until September 2015.”

The focus of these cases on a few months’ difference in disclosure timing is bizarre, however, for a fraud that affected 11 million vehicles and was planned over 17 years. Winkerkorn, for example, is a highly-trained technical engineer who earned a reputation over 35 years at VW as being “[a] fastidious perfectionist with the nickname ‘Mr Quality.’” He once jokingly boasted that he knew “every screw in our cars.” If he, the board, and other top executives did not know about the deception, it is because they did not want to know.

Third, the charges brought for the harms inflicted do not fit the substantive wrongdoing. When VW settled with the U.S. federal government and other authorities, it merely admitted to not telling the truth about its deception. The criminal charges against VW and its executives are for covering up the organization’s crime, not for the crime itself. From the beginning of the case, the charges against VW and variously against its executives have been (1) conspiracy to defraud the government, (2) obstruction of justice, and (3) entering goods into the country by false statement. VW AG has pleaded guilty to all three charges. One of its executives has pleaded guilty to conspiracy to defraud the government. Versions of the same disclosure-based charges are pending against six additional VW executives.

But on these narrow disclosure-based charges, even the company and its sole executive who have pleaded guilty have never taken responsibility for VW’s real crime. In a street setting, this is similar to committing murder and merely being charged with lying to the police about where the body is hidden. Where are the charges for the underlying wrongdoing? This flaw in charges is not isolated to the treatment of VW, but can be seen in the Takata case and other recent scandals. Most importantly, the lesson that VW and other business organizations take away from these cases is not “don’t commit the substantive crime,” but “do a better job of hiding it.” The effect of our current ‘don’t ask, don’t tell’ system is merely to encourage corporations to hide their deceptions more effectively, thereby increasing the degree of harm from those actions before they are discovered.

All these characteristics of modern large-scale corporate crime show that, by relying on disclosure-based regulation for prosecutions, we teach business organizations and top executives with disclosure duties to be willfully blind about what is happening inside their organizations so that they do not have to disclose bad behavior. Under pressure for results without inquiry into methods, middle management is able to coordinate large-scale wrongdoing without consequence. Securities rules supply information to investors on the theory that the marketplace will discipline companies, but fail in practice because investors do not react to violations the way that regulators do, because companies disguise the importance of information by flooding the market, and because disclosing information—even in the footnotes of a report—can act as a shield when there is no other practical liability for the corporation’s underlying acts. Meanwhile, a few executives and the corporation pay at the end of the line for lying to regulators or argue over the timing of their public statements to investors. Victims may or may not receive restitution, but disclosure-based enforcement does nothing to change underlying behavior.

My article proposes an ‘easier ask, let individuals tell’ approach to preventing large-scale corporate wrongdoing. As in highly-effective anti-money-laundering laws or in state rules that require teachers to report suspected child abuse directly to authorities, employees at all levels of an organization should have a duty and be involved in reporting harmful behavior without the burdens imposed on whistleblowers. In addition, we should no longer force business organizations to pay for vast and irrelevant increases in their compliance budgets, but instead shift to regulators the financial obligation of analyzing information about how and when large-scale crimes may be taking place. As large-scale wrongdoing increasingly occurs across corporate forms and the marketplace, corporate-level compliance programs will be less effective, and regulators will need to look for patterns in reports not necessarily available at the entity level. These would be the first steps to better protect the public and curb damages from large-scale corporate crime.

ENDNOTE

[1] “Don’t ask, don’t tell” was a description coined in the 1990s originally to describe President Bill Clinton’s policy of ignoring the sexual orientation of troops serving in the U.S. military. It was repealed because it failed to address the substantive issue of whether the U.S. military was open to people of all sexual orientations who wanted to serve, and, in the meantime, was destructive of thousands of soldiers’ lives.

This post comes to us from J.S. Nelson, a professor at Villanova Law School who also has a courtesy appointment at Villanova Business School. It is based on her recent paper, “’Don’t Ask, Don’t Tell’ Corporate Crime” available here.