Prosecutors, massive fines and moral hazard

Many years ago, I lived next door to a young police officer and his family who, while presumably paid a modest salary, drove a pretty expensive car.   He was able to do this, I learned, because his department seized autos (and other property) of various suspected offenders and then let its officers drive the vehicles for their personal use.  Although he seemed in every respect like an honorable young man, the impact that this practice could have – and also appear to have – on law enforcement decisions left me feeling uneasy.

The latest issue of The Economist has a sweeping indictment of the US system of business law enforcement.  There are many components to this assault, including that: large fines are, in effect, extorted from companies, but the guilty individuals often go free (which, in my view, is quite true); settlements of these cases often obscure facts that should be made known to the public (with which I also agree); US laws are so numerous and complicated that companies face a grave risk of prosecution for conduct that they never could have suspected was wrongful (with which I agree only slightly); and part of the cost of this system is that “[e]normous amounts of time and money are now being put into compliance programmes that may placate judges, prosecutors, regulators and monitors but undermine innovation and customer services” (which I also think is an overstatement,  but also is true enough for companies to be careful not to go overboard in their compliance programs).   But the critique that interested me the most concerned the view that the prospect of recovering large fines influences law enforcement decisions, i.e., a corporate variation on the story in the first paragraph of this post.

This part of The Economist article relied in part on a paper in the January 2014 Harvard Law Review – “For-Profit Public Enforcement,” by Margaret H. Lemos (Professor, Duke University School of Law)   and Max Minzner, (Professor, University of New Mexico School of Law), in which the authors seek to show “that public enforcers often seek large monetary awards for self-interested reasons divorced from the public interest in deterrence. The incentives are strongest when enforcement agencies are permitted to retain all or some of the proceeds of enforcement – an institutional arrangement that is common at the state level and beginning to crop up in federal law. Yet even when public enforcers must turn over their winnings to the general treasury, they may have reputational incentives to focus their efforts on measurable units like dollars earned. Financially motivated public enforcers are likely to…undertake more enforcement actions [and] focus on maximizing financial recoveries rather than securing injunctive relief,… Those effects will often be undesirable, particularly in circumstances where the risk of over-enforcement is high.”

I don’t know if it is quite right to call this a conflict of interest, but it does seem close to a moral hazard, in that those with power to reduce risks (prosecutors) may have interests that are not well aligned with those who bear the consequences of their actions (the public).  Moreover, and independent of this concern, prosecutors sacrificing tomorrow’s interests (as the benefits of deterrence take place entirely in the future ) for a quick buck today – the very trade-off for for which guilty companies are often castigated  – itself can be harmful because, as Justice Brandeis famously said: “Our government is the potent, the omnipresent teacher. For good or for ill, it teaches the whole people by its example.”  

(For more on moral hazard see the posts collected here. And here is a post on implications for risk assessment of the government’s seeking large financial recoveries from corporate defendants.)

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