“The next time you see a company investigated you can characterize the activity in one of two ways: “There but for the grace of God go I” or “What could those guys possibly have been thinking?” The Department of Justice makes no distinction between risks that are taken in the conduct of business and outright negligence.”
–Professor Jonathan Macey
Jonathan R. Macey’s trenchant humor belies his true calling as a serious arbiter of corporate and securities law, regulation, and governance. Macey is the Sam Harris Professor of Corporate Law, Corporate Finance, and Securities Law at Yale Law School, and the author of The Death of Corporate Reputation: How Integrity Has Been Destroyed on Wall Street (FT Press, 2013).
What governance area has held your focus since you published your book?
I have been ranting about the government’s reflexive reaction to impose greater responsibility and liability on corporate directors. It is a grossly oversimplified reaction to whatever troubles us in the boardroom or in the world.
At one time, targets of government lawsuits were assumed to be guilty. How do you advise your law students to think about government investigations?
I tell them the next time you see a company investigated, especially by the federal government, you have to characterize the activity in one of two ways. The first is, “There but for the grace of God go I.” And the second is, “What could those guys possibly have been thinking?” The first instance applies to an example like JP Morgan and could happen to any major financial institution, and will occur again in the future. The part that concerns me is that the Department of Justice makes no distinction between risks that are taken in the conduct of business and outright negligence.
What is the attorney general thinking when he imposes such outrageous penalties?
I would describe it as if the government is watching a carpenter hammering a nail, and the carpenter whacks his thumb. The government tells the carpenter, “We saw you hurt your thumb, but the pain you have experienced was insufficient to deter you from future carelessness or to deter other carpenters, so here, let’s take another whack at your thumb.” The government piles on an additional billion in penalties for no other apparent reason than to reinforce the pain—only it’s the shareholders who suffer. Let’s call this the “risk that a company has taken a risk.”
What’s the real motivation here for the regulators?
Job satisfaction. Today, regulators at the SEC and in its enforcement division as a whole are evaluated on the basis of strange and highly imperfect criteria. In particular, the SEC’s congressional overseers and the financial press tend to evaluate the SEC’s performance by measuring how much money they collect in fines every year—the more you collect in fines, then the better job you’re doing if you’re the SEC or the Justice Department. In addition to the dollar amount of fines collected, regulators are judged by the sheer number of cases brought each year. Under this criterion, regulators are highly motivated to settle rather than to actually litigate cases, because it’s much easier and cheaper to settle than to try a case. So multiple cases can be brought and settled for the cost of actually litigating a case. These same perverse incentives also apply to the Department of Justice.
It sounds as though the Justice Department and regulators are operating more like bounty hunters than law enforcers.
It used to be that regulators were criticized for going after the small fry and ignoring the big fish. The SEC ignored [Bernard] Madoff for years based on this hypothesis. Now smaller companies are often given a pass because regulators can sue big, deep-pocketed firms like
JP Morgan Chase or Goldman Sachs multiple times and collect huge fines. Big money-center banks and large organizations will be sued repeatedly because, as Willie Sutton said, that’s where the money is. But these same regulators lack strong incentives to pursue small companies. This lack of oversight of small firms almost certainly will lead to our next regulatory catastrophe.
Then how would you characterize the government’s investigation of Goldman Sachs and the Abacus trade?
The SEC essentially makes a misrepresentation of a material fact when it indicates that it is helping the little guy. The U.S. government pursued a U.S. defendant to obtain money for sophisticated counterparties like the Dutch ABN Amro and Germany’s IKB Deutsche Industriebank, who were more than competent enough and wealthy enough to hire their own damn lawyers and have them bring lawsuits against Goldman.
You did a paper on the distorted incentives facing the SEC.
Yes, I did. In a world of unlimited resources and very little wrongdoing, I would have no objection to the SEC bringing a case like Abacus. But when you have lots of real people, tax-paying U.S. citizens with limited means, unable to pursue legitimate wrongdoing because they lack the resources to fund a lawsuit against a financial institution, and the SEC has to triage their case selection because of their limited resources, then the decision to invest those limited resources to sue Goldman for the Abacus trade is execrable.
Let’s talk about director liability and the courts.
Lawsuits and the threat of lawsuits against corporate directors are an endemic problem in the U.S., particularly in M&A transactions, where the probability of being sued after doing a deal approaches 100 percent. One problem is that the way we organize legal education influences the mind-set and intellectual orientation of judges and legislators. Unfortunately, deficiencies in law school education have produced generations of lawyers and judges who are unwilling or incapable of understanding that expanding the scope of liability has costs as well as benefits. Nobody considers the time directors and officers spend in deposition, or the cost of mounting a defense, or the disincentives facing qualified people who might serve on boards if the threat of litigation, not to mention ridicule and excoriation, were not so significant.
Are directors paying enough attention to these facts?
No one should serve on a board without consulting an attorney and having the attorney look at the D&O policy. In fact, companies should be sure their director candidates have had the benefit of outside counsel before being seated on a board.
What was your motivation for writing The Death of Corporate Reputation?
I saw the need to bring in the concept of reputation as it relates to the subject of corporate and securities law. Take, for example, banks and their clients. This is a relationship that has been transformed from a customer relationship to mere counterparties with no rights or expectations of being treated fairly.
Have we replaced customer satisfaction with shareholder satisfaction?
In a sense, we have forsaken longer-term shareholder satisfaction for the short term, and in doing so, the customer-client relationship has been weakened severely so that today many firms are no longer bound by any particular moral code, and the consequence is a perverse set of incentives to rip customers off rather than build trust.
Shifting to the Volcker Rule, what is your take on the confusion that will cause?
I look at the massive costs of complying with the Volcker Rule as essentially a tax on corporations and a prodigious wealth transfer from shareholders to lawyers and regulators.In my opinion, rather than have financial institutions spend billions of dollars on compliance and legal costs attributable to the Volcker Rule, why not have these same financial firms pay those billions into a fund that would be used to compensate creditors? This approach provides for remedies, whereas our current approach only supports legions of well-heeled corporate lawyers and faceless government bureaucrats.
Where does all this leave us? Will capitalism get wobbly?
I think we are looking more like Europe or Japan—less productivity, slower growth, general malaise. I don’t think there’s going to be a collapse, but there may be a long, slow relentless decline. You can describe me as cautiously pessimistic.