Angelo Mozilo, ex-CEO of Countrywide, flooded the financial system with essentially worthless mortgages. This was perfectly legal. Countrywide paid Mozilo millions for producing short-term earnings and stock returns that disappeared overnight when the crisis hit. This, too, was perfectly legal. During his tenure as CEO, Mozilo privately sold shares while publicly disguising Countrywide’s financial health. For this, he was charged with insider trading and securities fraud by the SEC. The Wall Street Journal estimates Mozilo’s total executive compensation at $470 million. He settled with the SEC for $67.5 million, less than 15 percent of that.
America needs to be tougher on its white-collar criminals and bad managers. Angelo Mozilo is a perfect case study, but plenty of others would have served just as well. Steven Rattner settled for $10 million dollars, a charge tantamount to bribery. Kenneth Lay led Enron to the dust, while pocketing $40 million dollars. He spent almost all of it on legal defense, delaying trial and dying without sentence on vacation in Colorado.
America needs to be tougher on its white-collar criminals and bad managers — but that doesn’t mean it has to do so through the court system alone.
These paltry settlements are proof that the judicial system cannot adequately handle corporate criminals. The situation is quite simple. Say a defendant steals large sums of money from his shareholders. If the defendant then stands trial over his right to keep that same large sum of money, he will rationally spend much of that money on lawyers. Kenneth Lay did. The set-up is designed to fail, or at least cost the litigators an unjust and inefficient sum.
The courts are working double duty. They are the arena in which shareholders try to get their money back. But they are also the arena in which the former executive can use this money to avoid jail. Delays in the first setting deny justice in the latter. The longer it takes to return stolen money, the harder it is to bring the robber to jail.
A criminal who steals millions of dollars should be assured at least as much jail time as a criminal who steals from a convenience store. If corporations can gain more leverage and speed in recovering stolen assets, the criminal justice system has a better shot of putting the crooks behind bars.
Corporations must push arbitration clauses into executive compensation contracts. Here, Mozilo stands as a great example. The man allegedly profited by misleading investors. During the trial, the U.S. courts must presume innocence and allow Mozilo to deplete all of his questionably earned wealth in defending himself. Ex ante, shareholders could have struck a tougher contract with Mozilo. For example, the contract could demand that in the case of suspected misconduct, Mozilo should face his plaintiffs in private arbitration with very limited access to legal funds.
Corporations must also push “claw back” clauses for disappearing short term profits. According to the SEC’s charges, Mozilo made $139 million through insider trading and securities fraud. This is a cartoonishly large total. But it is only a fraction of Mozilo’s $470 million in total pay. He made the balance by cashing in on short-term profits that left Countrywide bankrupt in the long-term. This is perfectly legal. Shareholders could disincentivize this behavior before the fact, and recollect ill-gotten gains after the fact by demanding “claw back” clauses to recollect executive pay earned before the full ramifications of a strategy plays out.
The question is, why don’t shareholders do this already? The answer is complicated. Part of the problem is the fact that board members and executive pay consultants are closer to the CEO than average shareholders, so they represent shareholder interests poorly. Such clauses may also get traded away at the bargaining table, because they matter more to the executive than to the shareholder.
But it is not only in the shareholders’ interest to see executives behave themselves, it is also in the interest of the nation. And so it is incumbent on our government to nudge these clauses into compensation contracts if some market failure is keeping them out. The government is ill-suited to litigate executive crime directly, but it could and should levy taxes on companies that don’t have bullet-proof arbitration and claw back rights over their executives. Stopping the next financial crisis is a complicated task, but stopping the next executive crime shouldn’t be.
Nathaniel Schwalb is a junior in Ezra Stiles College.