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Two major investment banks, Citigroup and J.P. Morgan Chase, have agreed to pay some $300 million in fines and penalties for helping Enron to avoid representing its financial condition fairly and accurately. What effect did the fines have on the financial well-being of these banks? Their stock went up the day the fines were announced, a day in which broader market indices declined. While prosecutors celebrated this unprecedented settlement, so did the banks’ investors. When corporate fines lead to a sigh of relief from shareholders, they are not likely to succeed in deterring future bad conduct. To be effective, penalties must be tied to the financial performance of the company that did wrong. Their computation should be based not on some abstract notion of how much is “a lot,” but rather on the amount of time it will take the company to earn back the money it had to turn over because of its bad behavior. A drop in a million-dollar bucket For example, in its June filing, Citigroup reported assets of more than $1.1 trillion. Its share of the fine, $126.5 million, does not even make it on to the company’s radar screen. It is 0.0001% of the company’s assets. Compare this to a person who has saved $100,000 during his lifetime. A fine that took the same percentage of assets would amount to $10-a pizza. Alternatively, consider Citigroup’s income. During the three-month period ending June 30, Citigroup reported earnings of about $4.3 billion. The fine is just 2.9% of its quarterly income, or about two and a half days of profits, if it earns at the same rate for the entire year. The incentive to maximize profits sometimes leads corporate employees to exercise bad judgment in working to advance in their organization. Most of the benefit of ill-gotten gains goes to the company, which therefore may not do everything it should to discourage involvement in practices that are not entirely honorable. The situation is compounded by the fact that the stock options given to so many senior corporate managers gives them a double stake in tolerating wrongful conduct. Not only will they be doing their job well and aggressively for the sake of the shareholders, but they themselves will benefit handsomely from their own holdings. In the wake of the Enron scandal, Congress enacted tough legislation intended to increase accountability of corporate executives, accountants and lawyers, and to punish those who behave badly. The law, the Sarbanes-Oxley Act of 2002, does not go far enough, however. What is needed is for corporate leaders to know that they are hurting their shareholders when they act wrongly. Bad conduct must become bad business. An alternative that hurts Our system of criminal justice already has a partial solution for this problem: It can sentence companies that act wrongly to the equivalent of community service. When a person is sentenced either to prison or to perform a certain number of hours of community service, his anti-social behavior has cost him the right to devote a portion of his time to earning money for himself. Looked at in this way, one might say that Citigroup has agreed to about two days of community service by contributing the fruits of two days of profitable business activities to the public coffers. Perhaps this amount was all that even aggressive prosecutors could negotiate given the uncertain prospects of a criminal trial. Whatever its basis, the amount is not likely to be large enough to deter wrongful conduct in the future. J.P. Morgan Chase should take about nine days to earn back the somewhat larger fine it has to pay. It, too, has more than enough assets absorb this amount without blinking, which accounts for its shareholders’ reaction. But the two weeks it will take to replace this money- as opposed to two days-may begin to make at least a small statement to management and shareholders over time. In other cases, longer periods of community service would be appropriate. Major brokerage houses found to be pushing their retail customers into stocks that they knew are bad investments in order to curry favor with the companies that issued the stocks should perhaps be sentenced to turning a full year’s profits over to the public. That would amount to many billions of dollars. Creating special funds may also be appropriate in some cases. In fact, Citigroup and J.P. Morgan Chase’s fines will be paid in part to such a fund for victims of the Enron scandal. Government should reduce the temptation for corporate misconduct by imposing penalties that will make it unprofitable for a company to do wrong. It is not enough to punish the individuals. The incentive system must be changed as well. Sentencing companies to community service is one way of accomplishing this goal that uses a device already part of the criminal justice system. Of course, it cannot work for all corporate wrongdoers. Bankrupt companies, like Enron, have less to lose. Nonetheless, when two major banks are fined some $300 million, it should not be a time for their shareholders to congratulate the management for a job well done. Lawrence M. Solan is a professor of law and director of the Center for the Study of Law, Language and Cognition at Brooklyn Law School.

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