Prevention, Not Punishment is the Best Cure for Stock Fraud

by Lesley Ann Skillen

Published in the New York Times, September 4, 1994

To the Editor:

Frauds of the magnitude of that allegedly committed by Joseph Jett at Kidder, Peabody continue to plague Wall Street because the control of corporate fraud has been the province of prosecutors and regulators, whose function is largely reactive. Their work begins after the wrongdoing has occurred. Their job is to punish the wrongdoers and seek compensation for the victims.

In November 1991 the Federal Corporate Sentencing Guidelines became law. In contrast to traditional prosecutory methods, the Guidelines mandate a preventive approach to corporate crime control that assigns responsibility to each company to implement an anticrime program, to monitor compliance, to report any criminal conduct that is detected to the Government and to cooperate fully with the Government’s investigation.

The principles embodied in the Guidelines were publicly acknowledged in 1992 by the then United States Attorney for the Southern District of New York as the basis upon which he had decided not to prosecute Salomon Brothers for illegally acquiring $9.5 billion in Treasury securities. And yet the lesson of Salomon Brothers appears to have been only partly learned. While Kidder, Peabody’s current efforts to cooperate with the Securities and Exchange Commission and the United States Attorney are by all accounts exemplary, its internal anticrime controls were clearly ineffective to prevent one senior trader from allegedly fabricating profits in excess of $350 million while in fact causing losses of $85 million over a period of several years.

The Corporate Sentencing Guidelines rest upon a simple principle. Institutional crime is about institutions, not about bad apples whose conviction and imprisonment will make the problem go away. After-the-fact efforts to extricate companies from the potentially devastating impact of criminal and civil liabilities — like those at Kidder, Peabody in 1994, Salomon Brothers in 1992, and Drexel Burnham Lambert and E. F. Hutton in the 1980’s — are doomed to ultimate failure unless and until companies understand and apply the techniques of effective self-policing.

Such “policing” does not mean that the corporation becomes a cop and its employees the captives of a police state. What it means in the short term is that corporate managers focus on implementing a compliance program that satisfies both the letter and spirit of the Sentencing Guidelines. What it means in the long term is that companies accept responsibility for building a corporate culture in which ethical conduct goes hand in hand with profitability.