Columbia Law Professor John C. Coffee, Jr.’s Corporate Crime and Punishment delivers a hard-hitting and provocative analysis of the securities law enforcement landscape and the choices that lie ahead.  With SEC senior staff changes probable in any new administration, Coffee’s perspective is particularly well-timed.  Overall, this is a book designed to make us strongly disagree about important issues in a very good and productive way – a book that all who genuinely care about securities enforcement need to read, whatever their own views.

Coffee’s central thesis is that corporate America is undergoing a “crisis of underenforcement” marked by lenient resolutions of cases against companies and a reluctance to hold individual executives accountable for their companies’ misdeeds.  Defense lawyers may respond that we instead have a “crisis of overenforcement,” particularly with aggressive SEC actions against dozens of entities for industry practices long thought acceptable or that in years past might have drawn simply a deficiency letter.  But again, Coffee’s book goes out of its way to provoke opposing views to get all players in the enforcement process thinking hard about where it’s going at a pivotal moment.

Punishing the Corporation

Coffee is skeptical that the “steadily increasing level of fines on corporations” will yield real deterrence, particularly where even a  fine that seems large in dollars is small compared with an issuer’s market capitalization.  He observes that penalties would need to be “staggeringly high to make the expected penalty exceed the expected gain from” the challenged behavior.  And he expresses concern that further increasing penalties will have collateral consequences on other stakeholders like creditors and employees.  That’s a fair point, considering that just two decades ago a $10 million penalty could make jaws drop but today may seem routine.

As an alternative, he suggests what he calls “equity fines” – penalties that an issuer pays in stock instead of cash.  He postulates that this approach would let a court impose a greater fine without harming nonculpable creditors and employees.  But such equity fines would certainly hit the issuer’s shareholders through dilution.  He rationalizes this outcome by observing that shareholders are “diversified and indexed,” at least more so than the issuer’s executives, who would feel a stock penalty more.  He also argues that shareholders can oust management.  He proposes that shares from such an equity fine go to a trustee to liquidate over time for a victim compensation fund.  But implementing this approach would require legislation, which would surely face headwinds from corporations and shareholders.

Another idea he offers is corporate “probation” for a period of perhaps five years, which would feature conditions that are tailored to control the particular entity’s recidivism risk.  He suggests that such conditions could, for example, include restrictions on executives’ incentive compensation, perhaps limiting it to 25 percent of an executive’s total salary for the period, to discourage risk-taking and reduce pressure for short-term profits.  Again, however, such punishment would affect other corporate stakeholders like employees, creditors, and shareholders.

Punishing Individuals

In wrestling with the downsides of punishing companies alone, Coffee concludes that “adequate deterrence requires a focus on the individual executive,” which he calls “this book’s fundamental response.”  Coffee asks at the outset why so few individuals were criminally prosecuted following the 2008 financial crisis and compares outcomes in SEC civil cases involving the crisis to the serious prosecutions that followed accounting scandals in the early 2000s.  But at the same time he realistically acknowledges the “confounding problem” of individual prosecutions being difficult to bring.  And while unreservedly holding the view that there was “pervasive” fraud leading up to the 2008 crisis, he fairly recognizes that there are “two sides to this argument” about whether the 2008 crisis was born of criminal activity or, like the 1990s tech bubble, mere economic forces.

In any event, he rejects the view that prosecutors have been too “chicken” to go after senior leadership.  He believes instead that they “rarely get to the top of the corporate hierarchy” because resource-scarce prosecutors must “outsource” their work to a corporation’s own internal investigation, which Coffee deems “necessarily compromised” and likely to blame only low-level employees.  Instead of having internal investigations controlled by an independent committee of a company’s board, he would have prosecutors directly involved in the conduct of the investigation and the choice of investigating counsel, who would perhaps come from the plaintiff’s bar.

But even with prosecutors actively involved in internal investigations, there still would be challenges.  The matter may involve what he calls “an engrained and systematic corporate practice” that can be “industrywide.”  Senior leaders may have set only general goals and benchmarks for an entity, with midlevel managers having “little incentive to tell their supervisors that there are serious problems or risks in their line of business.”  And a modern company’s “decentralized structure” may present decision-making that is “diffused through various levels and divisions.”  Ultimately the operations personnel directly involved may number in the hundreds and may have been following what appeared to be established industry practices long considered acceptable.  In such circumstances, how do you pursue in a principled way one or more individuals for a crime that requires proof of intent – or even for a scienter-based civil violation in an SEC case?

Motivating Cooperation

Not surprisingly, Coffee is a big fan of the SEC’s whistleblower program.  He lauds its results in generating a substantial number of cases and recoveries against companies and individuals in just the 10 years it has been operating.  He echoes SEC leadership in calling it a game changer.

But for Coffee this is not enough.  To get results, he proposes that prosecutors create a “competition to cooperate” among the company and individuals accused of wrongdoing, with the first to “confess and cooperate” getting leniency and others harsh treatment.  He calls on prosecutors to “place the corporation and its executives into a competition for leniency,” where the first to cooperate may get leniency or even immunity, and where the government would “motivate the corporation, as principal, to turn in its agents,” including the company’s senior executives.

But left by the side of the road in this leveraged approach, some may say, is the justice system and, at its apex, the trial as a means for a jury to sift through the evidence, figure out what actually happened, and deliver justice.  While bare-knuckled pressure forcing companies and executives into “competition” may deliver fast results to prosecutors, how confident are we that those results will be correct, balanced, and fair?  As with all the questions in this thoughtful book, there are no easy answers.

Pursuing Securities Cases

Coffee chastises criminal prosecutors for folding too quickly and on easy terms in deferred prosecution agreements that provide for just a fine and perhaps a temporary corporate monitor with limited powers.  And he similarly criticizes the SEC for settling civil cases on easy terms to boost case statistics and support budget requests – albeit settlement terms that often look far from easy to the defendants.  This criticism of course raises the age-old question whether the government should do fewer securities cases but pursue them to the full extent and maximize recovery or instead bring many more cases by resolving them quickly with acceptable results that expose wrongdoing.  Settlement decisions will always involve a balance struck in real time depending on a case’s unique circumstances.

Coffee somewhat unrealistically suggests that the SEC and other regulatory agencies hire class action plaintiff’s lawyers to handle their big cases for contingency fees.  He believes that these firms have the resources to pursue matters for years, and that they would agree to cede to the SEC ultimate control over the litigation and discretion about whether to accept particular settlement offers.  But plaintiff’s firms tend to be smaller in size, and the aggressive litigation he wants will often be too expensive for a small firm to pursue for five years or longer without periodic compensation to cover costs and with only a contingent fee possible at the end of a very long road.

Presently the SEC fields a litigation team in the hundreds, larger than all but the biggest law firms.  Lead SEC trial counsel are often former assistant U.S. attorneys or litigation partners from big law firms, as well as experienced agency lawyers promoted through the ranks.  Yet including overhead, the SEC probably gets this talent for under $200 per hour, less than private firms charge for paralegals.  That’s not a deal the SEC should think about giving up.

Read This Book

Coffee delivers admirably on his opening promise of a readable, even entertaining, book that will not be “academic” and will instead strive to “reach a broader audience.”  (Detailed notes supporting his analysis and scholarship are tucked discreetly at the back.)  And it’s a book that’s well worth the reader’s time.

Those who have seen Coffee teach or run programs for practitioners will recognize that this book features him at full strength.  The high-energy host endlessly challenging his audience with his own creative ideas that just keep flowing, all the while ferreting out and encouraging others’ conflicting views and additional or different ways to deal with issues.  This book is a must-read that is designed to provoke sincere and principled disagreement, and thereby creative thought, in one of the most dynamic areas of modern American law, just as it enters a new and unprecedented era.

This review comes to us from Stephen J. Crimmins, a partner at the law firm of Murphy & McGonigle PC, based in New York and Washington.