Punishment -- But No Admission of Wrong

Late last year, a federal judge overturned an SEC settlement with Citigroup in which the company was fined over $200 million for financial misconduct -- yet admitted no wrongdoing. The judge criticized the longstanding practice of allowing for no admission of guilt -- a staple of nearly all government settlements with corporations and banks over the past decade.

The practice has long bugged me, too. After all, how is it that crimes clearly occur -- to the point that millions are paid out in fines -- and yet no individual is held responsible and no one admits doing anything wrong? These settlements epitomize a double standard around personal responsibility: Two million people sit in America's jails and prisons amid a historic crackdown on crime, yet executives who have orchestrated major white collar crimes aren't even forced to admit they did wrong, much less face personal punishment.

Not long after the judge's ruling, the SEC said it was changing its policy on settlements and taking a tougher stance on admission of wrongdoing in some cases.

Unfortunately, business continues as usual in other enforcement arms of the federal government. Case in point is yesterday's settlement by the FTC with Asset Acceptance, a debt collection agency that will pay $2.5 million. Although the company was charged with nine separate complaints -- like "using illegal debt-collection practices, including misrepresenting the character, amount, or legal status of a debt; providing inaccurate information to credit reporting agencies; and making false representations to collect a debt" -- the company did not admit to wrongdoing. (It did promise to change its debt collection practices, though.)

Among other things, Asset Acceptance broke the law when it called third parties -- like employers -- to try to collect debts. Imagine that: some debt collector calling your boss or a relative about your debt.

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Cheating on the U.S. News College Ratings

It was unsurprising to hear, as we did Tuesday, that Claremont McKenna College had lied about its students’ SAT scores to boost its position in the U.S. News & World Report annual ranking of colleges. University officials are famously obsessed with these rankings, and this is not the first time that a school has admitted fudging data. Just last year, Villanova Law School said that it had given false information to U.S. News.

Today we quantify and rank the performance of people and institutions as never before – all in pursuit, supposedly, of better outcomes and greater efficiency. Yet this obsession with metrics, a hallmark of the free-market ideology, invariably creates more incentives to cheat.

University presidents fret endlessly about the U.S. News rankings because they can have dramatic effects on everything from the quality of student applicants to the ability of schools to attract faculty and raise money. In an earlier era, one free of U.S. News, schools would not have had much reason to lie about SAT scores or admission rates. But now, with these numbers seen as hugely important, you can understand the temptation to monkey around with the reported data.

It’s not just colleges. Metrics have also taken over our K-12 schools, and they’re worse off for it. The education world has been roiled by major scandals recently in which administrators and teachers have been found to have manipulated student scores on standardized tests. These have not been isolated incidents, with revelations of false reporting in Atlanta, Chicago, Washington, Birmingham, New York City and Los Angeles.

It’s no secret why so many teachers and administrators are fudging test numbers: The pressure surrounding high-stakes testing is evident enough in the phrase itself. Tests now determine how schools are funded and, in some places, which teachers get bonuses. Incentives to cheat are baked into this system, and those incentives will only grow if more localities link teacher performance to compensation.

Similar temptations are elsewhere, with more disastrous consequences. The ever-greater focus on quarterly earnings by public companies has partially led to a rising tempo of corporate scandals since the 1990s. Executives, fearing shareholder backlash, have cooked the books to prop up stock values – most sensationally in the gigantic Enron and WorldCom frauds. (The Japanese manufacturing company Olympus is now embroiled in a major accounting scandal of its own.)

Executives didn’t used to obsess much about quarterly earnings, according to former CEOs I interviewed for a book I wrote about the Harvard Business School class of 1949. Now these numbers dominate corporate culture and pervert both business decisions and the ethics of executives.

Other examples abound of how a growing focus on bottom-line results can bring out the worst in people.

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Making the Rich More Accountable

President Obama made a strong stab at outlining a progressive narrative last night that envisions a nation where "everybody plays by the same rules." It's a pretty simple idea, tapping the powerful American ideal of egalitarianism -- that all of us should get a "fair shot" and that nobody is too high and mighty not to be held responsible for their actions. 

Of course, the obstacles to realizing this vision are enormous, particularly when it comes to ensuring equal accountability before the law. The rich are able to get away with misdeeds because their wealth enables them to block or water down rules aimed at curbing such behavior and can also be used to hire armies of lawyers and lobbyists when the authorities do come after them.

The U.S. is not nearly as bad as, say, Russia in this regard, but we are far, far away from a society where everyone is held equally responsible for their actions. And, ironically, we have moved further from that ideal over the past two decades during the same period when many politicians have trumpeted "personal responsibility" at every turn. That concept, it turns out, has been mainly applied to poor people and especially African-Americans -- not to rich people who actually have fewer excuses for being irresponsible. Indeed, many of the same conservative politicians who have been most obsessed with "personal responsibility" have helped to make it easier for the rich and corporations to do whatever they please without fear of sanctions. Witness the rollback of rules governing Wall Street or the weakening of labor laws that protect workers from abusive employers or the hollowing out of the IRS's enforcement capacity.

So it was nice, last night, to hear President Obama call for steps to ensure accountability for all. Specifically, Obama pledged anew to see that justice is done in regard to the biggest white collar crime spree in U.S. history -- namely all the abuses that led up to the 2008 financial crisis:

We will also establish a Financial Crimes Unit of highly trained investigators to crack down on large-scale fraud and protect people’s investments. Some financial firms violate major anti-fraud laws because there’s no real penalty for being a repeat offender. That’s bad for consumers, and it’s bad for the vast majority of bankers and financial service professionals who do the right thing. So pass legislation that makes the penalties for fraud count.

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Doctors Cheated on Exams

CNN reports on cheating by radiologists:

For years, doctors around the country taking an exam to become board certified in radiology have cheated by memorizing test questions, creating sophisticated banks of what are known as "recalls," a CNN investigation has found.

The recall exams are meticulously compiled by radiology residents, who write down the questions after taking the test, in radiology programs around the country, including some of the most prestigious programs in the U.S.

"It's been going on a long time, I know, but I can't give you a date," said Dr. Gary Becker, executive director of the American Board of Radiology (ABR), which oversees the exam that certifies radiologists.

Asked if this were considered cheating, Becker told CNN, "We would call it cheating, and our exam security policy would call it cheating, yes."

Lies, Losses, and Subprime Loans: The Freddie and Fannie Cases

Prosecuting white collar criminal cases is famously hard, but there may be an easy way to bring some of the top culprits behind the financial crisis to justice: Show that they lied to investors. Last week, the SEC brought the biggest such case yet, going after former executives of Fannie Mae and Freddie Mac. Here's how the case is describe in the SEC's press release:

"Fannie Mae and Freddie Mac executives told the world that their subprime exposure was substantially smaller than it really was," said Robert Khuzami, Director of the SEC's Enforcement Division. "These material misstatements occurred during a time of acute investor interest in financial institutions' exposure to subprime loans, and misled the market about the amount of risk on the company's books. All individuals, regardless of their rank or position, will be held accountable for perpetuating half-truths or misrepresentations about matters materially important to the interest of our country's investors."

The SEC's complaint against the former Fannie Mae executives alleges that, when Fannie Mae began reporting its exposure to subprime loans in 2007, it broadly described the loans as those "made to borrowers with weaker credit histories," and then reported — with the knowledge, support, and approval of Mudd, Dallavecchia, and Lund — less than one-tenth of its loans that met that description. Fannie Mae reported that its 2006 year-end Single Family exposure to subprime loans was just 0.2 percent, or approximately $4.8 billion, of its Single Family loan portfolio. Investors were not told that in calculating the Company's reported exposure to subprime loans, Fannie Mae did not include loan products specifically targeted by Fannie Mae towards borrowers with weaker credit histories, including more than $43 billion of Expanded Approval, or "EA" loans.

Fannie Mae's executives also knew and approved of the decision to underreport Fannie Mae's Alt-A loan exposure, the SEC alleged. Fannie Mae disclosed that its March 31, 2007 exposure to Alt-A loans was 11 percent of its portfolio of Single Family loans. In reality, Fannie Mae's Alt-A exposure at that time was approximately 18 percent of its Single Family loan holdings.

The misleading disclosures were made as Fannie Mae's executives were seeking to increase the Company's market share through increased purchases of subprime and Alt-A loans, and gave false comfort to investors about the extent of Fannie Mae's exposure to high-risk loans, the SEC alleged.

In the complaint against the former Freddie Mac executives, the SEC alleged that they and Freddie Mac led investors to believe that the firm used a broad definition of subprime loans and was disclosing all of its Single-Family subprime loan exposure. Syron and Cook reinforced the misleading perception when they each publicly proclaimed that the Single Family business had "basically no subprime exposure." Unbeknown to investors, as of December 31, 2006, Freddie Mac's Single Family business was exposed to approximately $141 billion of loans internally referred to as "subprime" or "subprime like," accounting for 10 percent of the portfolio, and grew to approximately $244 billion, or 14 percent of the portfolio, as of June 30, 2008.

This case may prove to be just the tip of a very large iceberg of government cases against former financial executives, since there is ample evidence that many other firms mislead investors about the quality of investments.