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Thursday, Aug. 01, 2002

What is the purpose of a corporation? Many might simply answer, "to make money." Indeed, the economist Milton Friedman famously declared that business has one, and only one, social responsibility: "to increase its profits." Or, as Gordon Gecko, the Mephistophelean character in the movie Wall Street memorably proclaimed: "Greed is good!"

Recent events, however, suggest quite the contrary. The unrestrained pursuit of profit for profit's sake engenders a climate in which CEOs, officers, and managers often break laws, or at least bend them as far as possible, to the great detriment of shareholders, the public, and confidence in the markets.

Just as humans are not simply breathing machines because they require air to survive, so too corporations are not just profit machines simply because they require revenue. As our President stated during his July 9th speech on Wall Street, "there is no capitalism without conscience, there is no wealth without character." The Sarbanes-Oxley Act of 2002, signed into law Tuesday, indicates that Congress also agrees.

A Privilege Granted for the Public Good Turns into a Profit Machine

As Justice Brandeis explained in 1933 in Louis K. Liggett Co. v. Lee, the privilege of the corporate form initially was granted "to promote more generally the public welfare by providing an instrumentality of business which will facilitate the establishment and conduct of new and larger enterprises deemed of public benefit."

By the late Nineteenth Century, however, that fear increasingly began to be realized. Worse, the least scrupulous states tended to make the most profit - there, "the cost was lowest and the laws least restrictive" for corporations that sought simply to maximize their profits. The classic race to the bottom, in which the state with the most pro-corporate laws won, ensured the "laxity" of the laws.

Even in 1933, during the turmoil of the Great Depression, Justice Brandeis worried presciently that due to the advent of huge corporations, "the lives of tens or hundreds of thousands of employees and the property of tens or hundreds of thousands of investors are subjected, through the corporate mechanism, to the control of a few men."

The dispersion of share ownership and lack of shareholder participation in management, Brandeis explained, had "removed many of the checks which formerly operated to curb the misuse of wealth and power," and led to increasing concentration of power "in the hands of a few" - and ultimately to a potential "plutocracy."

The Sarbanes-Oxley Act of 2002: Dramatic Corporate Reform

Not since the Securities Exchange Act of 1934 has Congress directed so much attention to the conduct of business and the professions. And not since the Great Depression era have so many been so worried about their financial security and the financial stability of our economy.

The Sarbanes-Oxley Act of 2002 is designed to address some of the concerns that Justice Brandeis raised so long ago, and that recent scandals have underscored. It is a compilation of several legislative initiatives. Its purposes are, first, to overhaul corporate governance and, second, and to increase the accountability of accountants, lawyers, and financial analysts.

The Act represents a concerted effort to curb not just the evils of wealth and power, but also the misuse and abuse of the corporate form privilege at the hands of greedy professionals. If implemented properly, it should change both how a public corporation operates and how it is funded.

The Act creates a Public Company Accounting Oversight Board to oversee audits of public companies. It also seeks to remove auditor conflicts of interest - such as those that occur when an auditing firm simultaneously provides both auditing and consulting services to the same client. Securities analysts' conflicts of interest - such as those that occur when they recommend stocks in reports or public appearances - are also addressed.

Affirmative duties are placed on attorneys as well. An attorney must report "evidence of a material violation of securities law or breach of fiduciary duty" to the company's General Counsel or CEO - and, if he or she does not respond appropriately, to the audit committee of the board of directors, or some other independent entity.

The Act also provides for criminal penalties. It creates or revises three felonies. The first is destruction, alteration or falsification of any record with the intent to impede a federal investigation, which is punishable by up to 20 years imprisonment. The second is destruction of corporate audit records, punishable by up to 10 years imprisonment. The third is securities fraud, which carries the most serious maximum penalty: 25 years imprisonment.

Additionally, the Act extends the maximum penalties for mail and wire fraud--which are the most common white-collar offenses as virtually any fraudulent scheme involves a phone call, email, or document sent by mail --from five years to 20 years.

In light of the newly created offenses and the increased penalties for white-collar offenses, the United States Sentencing Commission is directed by the Act to review the adequacy of the sentencing guidelines to deter and punish obstruction of justice and extensive criminal fraud. It is instructed to consider specifically whether the sentencing guidelines "are sufficient to deter and punish organizational criminal misconduct." And it is given "emergency amendment authority" to evaluate and amend as appropriate the sentencing guidelines for white-collar offenses.

Sarbanes-Oxley Will Not Work Unless Complemented by Creative Sentences

The Sarbanes-Oxley Act may not simply signal the beginning of a new era in corporate reform. It may also mark a return to the original concept of the corporate entity as a vehicle for promoting the general welfare and ensuring public trust. But that return will never be complete unless more is done.

As Enron demonstrated, white-collar crime is a very sophisticated offense that often can lay undetected for years, if it is detected at all. Realistically, regulation can never keep up with the sophistication of financial offenses.

And even if such offenses are detected, large corporations simply could have on staff an informal "designated felon" - the fall guy who takes the hit for the firm when the feds come knocking. Likewise, as the corporation itself can only be fined, not put in prison, fines may simply be absorbed as a cost of doing business. And even if a fine causes an organization to go bankrupt, many of the executives will land softly and safely with the aid of their golden parachutes.

With these obstacles, how can Sarbanes-Oxley ever be effective? The answer may lie with the Sentencing Commission devising more innovative sentences for corporations in order to complement the legislation - as the legislation itself invites it to do.

Building a Better Corporate Sentence

Under the Guidelines, the fact that a corporation (or other organization) had previously implemented and enforced a qualifying compliance program can significantly reduce penalties in the event that an offense does occur. Indeed, in some circumstances, the fact of an existing, effective compliance program also can convince the government, after an offense occurs, to decline prosecution and the existence of such programs may even minimize or eliminate civil liability.

Unfortunately, the existence of such programs did not prevent the current scandals because of the high-level involvement in the fraudulent activities. But the programs nevertheless remain a good idea - indeed, a necessity, due to the inherent obstacles to outside monitoring. Accordingly, reassessing the criteria for effective compliance programs may help greatly in implementing the intent of the Sarbanes-Oxley Act. Fortuitously, the Sentencing Commission recently formed an Ad Hoc Advisory Group on the Organizational Guidelines to reexamine the Guidelines' criteria for an effective compliance program. The Group is staffed by recognized experts in the fields of business ethics, compliance, and management and will be issuing recommendations to the Sentencing Commission approximately a year from now.

It is to be hoped and expected that as a result of the Group's timely and important work, the criteria for effective compliance programs will become further refined so as to maximally promote responsible oversight, transparency, and accountability. An effective compliance program, after all, can serve as the corporation's conscience. It can change a mere profit-seeking enterprise into a more responsible corporate citizen, one cognizant of its privilege and its true purpose, to promote the public's welfare as well as it own.

If current events demonstrate anything, it is that business and professional ethics are not, as the cynic would have it, oxymoronic phrases. They are, instead, a necessary foundation without which no entrepreneurial or professional enterprise can stand. Fostering and promoting ethics and compliance programs is an effective way of shifting the corporate paradigm from profit-only to responsible citizenship - and that shift is long overdue.

Mr. Allenbaugh is an Associate at Montedonico, Belcuore & Tazzara, P.C. in Washington, D.C., and is an Adjunct Professor in the Philosophy Department at the George Washington University where he teaches Ethics in Business and the Professions. Prior to entering private practice, he served as a Staff Attorney for the United States Sentencing Commission where he was assigned to the Economic Crimes Policy Team. Mr. Allenbaugh has published numerous articles on sentencing and criminal justice, and is a co-editor of Sentencing, Sanctions, and Corrections: Law, Policy, and Practice (2d ed., Foundation Press, 2002). He can be reached at

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