Archive for the ‘white collar crime’ Category

Insider Trading at the FDA

A scientist employed by the US Food and Drug Administration has been arrested and charged with insider trading.

Here’s the story, from Diana B. Henriques at the New York Times: U.S. Chemist Is Charged With Insider Stock Trades

A 15-year veteran of the federal Food and Drug Administration and his 25-year-old son were arrested on Tuesday and charged with systematically using confidential information about pending drug applications to reap millions in illegal trading profits since 2007.

As part of its drug-approval process, the FDA is given sensitive information by companies seeking such approval. And the status of a company’s application within the FDA’s own decision-making is itself sensitive information. Since FDA approval is essential to getting a drug to market, the announcement that a company’s drug has been granted, or denied, approval by the FDA can have a huge impact on the value of a company’s stock. And what FDA chemist Cheng Yi Liang did is to use information available only to FDA insiders to make profitable trades on the stock of companies then seeking FDA approval.

Just what was so wrong with what went on here?

In a statement announcing the case, Lanny A. Breuer, the assistant attorney general for the criminal division, said: “Cheng Yi Liang was entrusted with privileged information to perform his job of ensuring the health and safety of his fellow citizens. According to the complaint, he and his son repeatedly violated that trust to line their own pockets.”

Now Mr Breuer is clearly engaging in a bit of prosecutorial rhetoric. He’s right of course that Cheng Yi Liang was entrusted with privileged information, but there’s no obvious reason to think that his use of that information for personal gain jeopardized anyone’s health or safety. But fair enough: Mr Breuer is playing his role in an adversarial system, and that licenses a certain amount of hyperbole.

But what really is wrong with the kind of insider trading that Cheng Yi Liang engaged in? The precise worry about insider trading is the subject of some debate, and I’ve blogged about that before. (See: Ethics of Insider Trading.)

There are several ways we could get at just what was unethical about what Cheng Yi Liang did. One worry is that he profited unjustly, gaining money that he didn’t earn and had no right to. Also, in engaging in insider trading, he traded on information not accessible to others. That means that the people he traded with were at an unfair advantage, and likely lost money as a result. It also means that, subject as it was to significant information asymmetries, the market in which he traded was rendered slightly less efficient, as a whole.

There is of course another ethical worry: if chemists working for the FDA take a personal financial interest in the fate of various approvals, that could quite easily corrupt the work they do. In other words, it puts such a chemist into a conflict of interest. In a conflict of interest, what is fundamentally at stake is our trust in an individual’s judgment. If FDA scientists have a personal stake in their scientific work, then we have reason to doubt their judgment. And, worse, if the judgment of FDA scientists becomes subject to doubt, then the public ends up having a reason (though perhaps not a sufficient reason) to doubt the work of the FDA as a whole.

Ethics of Profit, Part 3: The Profit Motive

3 coinsThis is the third in a 3-part series on the ethics of profit. (See also Part 1 and Part 2.) As mentioned in previous postings, we should distinguish between our ethical evaluation of profit per se (which, after all, just means financial “gain”), and our ethical evaluation of the profit motive. After all, I don’t worry at all that Big Pharma makes big profits — that just means that they make products that lots of people think are worth paying for — but I do have serious worries about what people inside the pharmaceutical industry are willing to do to maintain those profits.

But we should be cautious about jumping too quickly to criticize the profit motive, either in particular cases or as a force in the economy as a whole. Here are just a few points:

1) People often suspect the profit motive — or at least, excessive focus on the profit motive, in the form of greed — of being responsible for a lot of corporate wrong-doing. But, anecdotes aside, that intuitive hypothesis isn’t necessarily well-supported by the facts. I’ve mentioned previously a paper by philosopher Joseph Heath* that points out that there are problems with the theory that greed is the root cause of a lot of wrongdoing. Corporate crime is actually more often aimed at loss-avoidance than at profit-making. And it’s also worth noting that we see lots of white-collar crime occurring at the top of organizations, committed by people who are already rich and who hence have relatively little to gain in financial terms. As Joe points out, the criminological literature has long since discarded the notion that greed is the root of all (or even most) evil.

2) Despite the fact that the traditional corporate (and anti-corporate) rhetoric has focused on the significance of profits, it’s probably much more likely that corporations and the key decision-makers within them are moved by a much broader range of motives, including things like:

  • A desire to increase market share;
  • The desire to innovate;
  • The desire to create cool products;
  • Basic competitive drives to be (and prove yourself to be) bigger, stronger, faster, smarter, etc.;
  • The CEO’s desire to build his or her personal legacy;
  • etc.

Of course, each of those motives can almost certainly result in wrongdoing too. But that just reinforces the point that even if the profit motive causes trouble, it isn’t unique in that regard.

3) The profit motive, whatever else it may do, plays 2 absolutely essential roles in any modern economy. Economist Steven Horwitz points this out in his “Profit: Not Just a Motive”. One role (as Adam Smith pointed out) is the basic one of motivating productive activity. Now, Smith never said that the profit motive is the only thing that motivates people to engage in production and trade. But what he did say is that even someone who doesn’t happen to have much love for his or her fellow human being is liable to end up doing something productive, even if only because he or she wants to earn a living. The other role for the profit motive is more subtle, and has to do with information. As Horowitz puts it:

What critics of the profit motive almost never ask is how, in the absence of prices, profits, and other market institutions, producers will be able to know what to produce and how to produce it. The profit motive is a crucial part of a broader system that enables producers and consumers to share knowledge in ways that other systems do not.

4) The profit motive also plays an essential role in modern corporate governance. Most large corporations are “owned” (in a very loose sense) by shareholders, to whom corporate managers and directors owe a fiduciary duty. In particular, managers and directors are obligated to try to make a profit. (Note that, contrary to what many seem to think, there is no obligation to actually make a profit, and the need to make a profit is not, in fact, legally binding or overriding. Shareholders only ever get a profit after a number of other, legally-binding, obligations — such as the obligation to pay workers, to pay suppliers, to provide refunds for consumers who bought faulty products, etc. — are met.) The strong obligation to try to make a profit for shareholders provides focus for managers. Rather than being pulled in 20 different directions by 20 different stakeholders, corporate managers have in mind that, yes, they need to keep in mind various stakeholder obligations, but all of that has to be part of an overall plan aimed at shareholder profits. Many people believe that this imposes a kind of discipline on corporate executives, without which those executives would be free to feather their own beds, throw lavish parties for their favourite charities (not necessarily the most needy ones), hire under-qualified siblings for key roles, etc.

5) Getting rid of the profit motive would essentially mean abolishing private ownership. When we talk about “profit”, we’re typically talking about the money that flows from owning something. It might be the landlord’s profit (i.e., whatever’s left after costs are subtracted from rent) or the shareholder’s profit (i.e., the dividend that might be paid out on the shares he or she owns, if the corporation happens to make a profit). Abolishing the profit motive basically means and end to permitting individuals to own things. So why do critics of the profit motive so seldom (in the last, say, 4 decades) propose ending private ownership? Hmmm. As Joseph Heath put it in “Learning to love the Psychopath” [PDF] (a review of the movie, The Corporation), “If public ownership is not the solution, then private ownership cannot be the problem.”

6) Even if we could keep our attachment to private ownership and wish into existence more “positive” motives than the profit motive, it’s not clear that we would be better off. Even if large numbers of executives (and shareholders) could be convinced not to aim at profit, but instead to aim at things like charitable deeds or the public good or world peace, it’s not clear that that would solve the problems we are most worried about. Does anyone really think that fraud couldn’t be, or indeed hasn’t been, committed in the name of charity? Does anyone believe that lies haven’t been told and thefts committed in the name of the public good?

None of this is intended as a blanket endorsement of profit-seeking. It’s just a reminder that in our haste to criticize the profit motive, we ought not ignore important questions about just what role the profit motive plays, what current institutions do to transform a range of motives into a range of outcomes, and what alternative motives and institutions are available to us.

*Joseph Heath, “Business Ethics & Moral Motivation: a Criminological Perspective,” Journal of Business Ethics 83:4, 2008. Here’s the abstract.

Regulating Wall Street Bonuses

The U.S. Securities and Exchange Commission has just announced its intention to exercise oversight over levels of pay on Wall Street. Is this an example of overreaching regulation, or of justified intervention in the public interest?

Here are the details, from Ben Protess and Susanne Craig, on the NYT‘s DealBook blog: S.E.C. Proposes Crackdown on Wall Street Bonuses:

Lavish Wall Street bonuses, long the scorn of lawmakers and shareholders, have met a new foe: the Securities and Exchange Commission.

The agency on Wednesday proposed a crackdown on hefty compensation awarded at big banks, brokerage firms and hedge funds — a move intended to rein in pay packages that encouraged excessive risk-taking before the financial crisis.

The proposal would for the first time require Wall Street firms to file detailed accounts of their bonuses with the S.E.C., which could then ban any awards it deemed excessive. The rules would be aimed at top executives and hundreds of rank-and-file employees who receive incentive-based pay….

In general, we should probably have as our starting point a healthy skepticism about government attempts to regulate pay in particular industries. Remuneration for high-level jobs is typically based on some combination of rewarding past performance and incentivizing future performance, in addition to sensitivity to things like skill, experience, and the scarcity of the particular talents the job requires. And it’s highly unlikely, again speaking in generalities, that government agencies are going to have the right information and motives to allow them to determine with any degree of precision and efficiency just what a private company’s pay structure should be. Now of course governments aren’t the only ones who could err in setting up compensation schemes; private companies are perfectly capable of screwing that up pretty badly themselves. But for the most part, if private companies screw up in that regard, it’s their shareholders that should hold them accountable, just as it is shareholders who ought to hold them accountable for any other foolish spending.

But there are likely to be justified exceptions to the general presumption in favour of the government taking hands-off approach to compensation. If it is the case — and this seems to be the S.E.C.’s conclusion, here — that compensation schemes in a particular industry are seriously and chronically causing harm beyond the walls of the organization, that seems to be a pretty good argument in favour of government action. This is especially true when the damage being done is not “merely” damage to particular individuals or groups, but to the stability of the economy as a whole. And as Protess and Craig point out, “The move by regulators to have more say on Wall Street pay highlights the huge role financial institutions play in the economy.” That is what arguably makes the harm done by Wall Street compensation not just a matter of private wrongs, but of public ones.

But of course, this argument doesn’t mean the S.E.C. should rush in like a bull in a china shop. All of the concerns mentioned above still apply — there are reasons why Wall Street firms have the compensation policies they have, and it’s pretty likely that at least some of those reasons are pretty good ones related to the necessities of the industry. Indeed, the S.E.C.’s chairwoman, Mary L. Schapiro, says that “This is an area where we want to be very attuned to unintended consequences.” The S.E.C.’s objectives here, seem to be good ones; the question will be whether the quality of the agency’s methods live up to the nobility of its goals.

Madoff, Accomplices, and Complicity

It takes two to tango. How many does it take to sustain a ponzi scheme?

See this tantalizing piece by Diana B. Henriques, for the NY Times: From Prison, Madoff Says Banks ‘Had to Know’ of Fraud

In many ways…Mr. Madoff seemed unchanged. He spoke with great intensity and fluency about his dealings with various banks and hedge funds, pointing to their “willful blindness” and their failure to examine discrepancies between his regulatory filings and other information available to them.

“They had to know,” Mr. Madoff said. “But the attitude was sort of, ‘If you’re doing something wrong, we don’t want to know….’”

Of course, as Henriques notes, “Mr. Madoff’s claims must be weighed against his tenuous credibility.”

But Madoff’s claims that others, including financial institutions and sophisticated investors, “had to know” something was wrong will ring true to anyone who knows the Enron story in detail. For a wonderful, if exhausting, tour through the Enron scandal, see Bethany McLean and Peter Elkind’s Enron: The Smartest Guys in the Room. As McLean and Elkind make clear, Enron’s shenanigans only went on as long as they did because a lot of people, at a lot of financial institutions (and accounting firms and law firms) spent years and years with their eyebrows raised but kept their mouths shut.

What do “Higher Standards” for Business Look Like?

When we see what seems to be an increase in misbehaviour, we need to ask: is that because behaviour has gotten worse, or because expectations have gotten higher?

See this piece, by Theresa Tedesco, for Financial Post Magazine: Farther. Faster. Higher.

…Business leaders are on trial like never before. Public outrage over recent ethical crises and the dramatic failures of corporate governance, most notably the stunning collapse of Enron Corp. and the financial crisis of 2008, have fuelled assumptions that government and regulators are stepping in and that ethical standards of business must be on the rise as a result. Certainly, public awareness is heightened in the aftermath of spectacular corporate collapses. But are ethical standards actually getting higher as a result? Or are shareholders, employees and other stakeholders simply more aware of the moral considerations in the wake of these scandals and crises, considerations that are soon to be forgotten? Either way, the role of the modern CEO and other senior executives has become much more complex, driven almost reflexively by the velocity of change in social values, technology, regulation and, increasingly, public opinion….

(I’m also quoted, making a point I’ve made before, namely that business is more ethical today than it has ever been in the past.)

But there’s also an interesting philosophical question, here, about what counts as a “higher” standard.

In some cases, “higher standards” might actually mean that we attribute to business obligations in domains in which they previously were seen as having basically no obligations at all. Environmental concern might be one such domain. Once upon a time, pollution just wasn’t an issue. At even once pollution was “on the radar,” so to speak, specific types of pollution (e.g., CFC’s) still weren’t seen as important. In that sense, it’s clearly true that we see “higher standards” imposed, and observed, by business today.

A second kind of “higher standards” might involve stricter requirements for things like honesty and product safety and truth in advertising. Once upon a time, the rule really was “buyer beware.” That’s no longer the case. Social expectations, often backed by law, mean that businesses face (and generally adhere to) standards far higher than we’ve ever seen before in history.

A third kind of “higher standard” might have to do with social expectations with regard to the impact business has beyond its interactions with its own customers and employees. Now, it has long been the case that many businesses make social contributions through things like charitable donations. But today, it is utterly run-of-the-mill for companies to have CSR departments that consider not just things like charitable donations, but how to track and report on the business’s net social impact. This is yet another way in which businesses face, and face up to, higher expectations.

But there is also a fourth kind of higher standard, one which is less-obviously being met. And that is in the area of individual decision-making. When the average person (or the ethicist, for that matter) surveys the world of business, he or she still sees examples of bad behaviour — people lying, cheating, embezzling, and defrauding. Most of us get our data in that regard from the media, which is far from a fair accounting of the issue. But still, the cases are out there. And it’s in that sense that people are very fair to observe that, at very least, things don’t seem to be getting better, dammit. Then again, I know of no credible evidence that things are getting any worse in this regard.

I suspect different people mean different things when they talk about whether “ethical standards” are higher or lower in business today. I suspect that the first 3 kinds of “higher standards” above are the crucial ones, since I suspect that the 4th, which depends on the character of individual human beings, is less susceptible to long-term change on a population basis.’s New White Collar Crime Blog, by Walt Pavlo

Here’s a new blog worth checking out. Walt Pavlo is now blogging for, a blog called simply White Collar Crime.

Walt is a special sort of expert on white collar crime: he was for a couple of years better known as “Inmate Number 52071-019” in the U.S. penal system. You see, Walt did time in a federal penitentiary for his part in the multi-million-dollar MCI-Worldcom fraud. So when he writes about white-collar crime — what motivates it, what allows it, and what its punishment looks like — he writes from experience.

I first blogged about Walt Pavlo in August of 2006, soon after meeting him in person (we were both speakers at the same event for MBA students at the University of Tulsa). Then, a couple of months later, I interviewed Walt to get his unique perspective on the 24-year sentence that had just been handed down to Enron’s Jeff Skilling.

Now, not everyone wants to hear what an ex-convict has to say. Fair enough. (As Walt himself wrote in his first blog entry, Not Every Felon Is Worth Hearing From.) For my part, I’ve already blogged on why I think convicted white-collar criminals are worth listening to. So for now, all I’ll say is that in my experience, Pavlo is a thoughtful and insightful guy. I’ll be reading his blog.

Here’s a link to Pavlo’s book about his own role in the MCI fraud, Stolen Without a Gun.

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