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Attack on corporate crime has thrown justice out of whack, legal expert says

6/16/2008

Christine Hurt
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Photo by L. Brian Stauffer
Law professor Christine Hurt says government crackdowns have made it easier for prosecutors to land criminal convictions than for shareholders to get relief in civil court stemming from the same corporate misconduct.

Jan Dennis, Business & Law Editor
217-333-0568; jdennis@illinois.edu

CHAMPAIGN, Ill. — A legal assault on corporate fraud has turned justice upside down, putting company executives at too much risk while leaving shareholders out in the cold, according to a University of Illinois law professor.

Christine Hurt says government crackdowns have made it easier for prosecutors to land criminal convictions than for shareholders to get relief in civil court stemming from the same corporate misconduct.

“That’s the opposite of the way the legal system is supposed to work,” Hurt said. “Generally, we want to protect criminal defendants because losing your liberty is a huge mistake and hard to remedy. In the civil system, we don’t protect the defendant as much because it’s only money, which never gets paid if the case is overturned on appeal.”

The disparity is rooted in two separate movements dating back to the mid-1990s that have thrown the playing field out of kilter in corporate misconduct cases, Hurt argues in a paper published in The Journal of Corporation Law.

In 1996, Congress passed the Private Securities Litigation Reform Act, raising the bar for civil lawsuits by shareholders who allege financial losses due to misconduct that caused stock prices to tumble.

“There was a concern that shareholders were bringing frivolous lawsuits that are very costly to defend, resulting in companies being blackmailed into settling non-meritorious suits,” Hurt said. “So, new laws and court rules raised new procedural obstacles that made shareholder suits very, very difficult to win.”

A few years later, Enron and other high-profile corporate scandals led to a massive criminal crackdown on corporate misconduct and broad reforms under the Sarbanes-Oxley Act, a 2002 law that includes stiffer penalties for fraud.

“President Bush created the corporate crime task force and federal prosecutors descended on the Enrons of the world, using all of the tactics at their disposal to get numerous guilty pleas and some convictions,” said Hurt.  “But the stockholders of Enron and other corporations found it very difficult to get relief in court.”

In fact, she said, the Enron shareholder suit was eventually dismissed, although a few defendants settled at the beginning of the sweeping criminal investigation.

“It sort of flipped what we thought about the legal system on its head,” she said.  “Corporate defendants were going to jail, but didn’t have to pay money to shareholders for the same acts, which is sort of an ironic paradox.”

Critics contend that reforms enacted in the wake of Enron and other scandals have “overcriminalized” corporate law, making it too easy for the innocent to be found guilty and creating penalties that sometimes
exceed the sentences for violent crime.

Hurt agrees, but argues that tougher standards for shareholder suits have also netted an “undercivilization” of corporate law that needs to be revisited by Congress.

“If you reform criminal law so that these guys don’t have to go to jail then they’re getting off scot-free because we have this civil law system that privileges them,” she said. “There’s not going to be any way to deter corporate fraud if we tighten up the criminal law spigot because the civil law spigot is already tightened. So we need to untighten the civil law spigot.”

Reforming criminal law but not civil law would also be yet another blow to stockholders, Hurt said. Parallel criminal prosecutions put pressure on corporate defendants to settle civil suits because a guilty plea or conviction may be used against them in those lawsuits.

“Any spillover effect civil plaintiffs received from parallel criminal prosecutions would be lost,” she said.

Hurt says some critics maintain the law that stifled civil suits may have fueled the scandals that erupted a few years later, emboldening executives who felt insulated from shareholder suits and engaged in more misconduct.

“There could be a causal effect, but regulators have been focusing reform efforts instead on the criminal side, " Hurt said.  "I think they’re looking in the wrong direction.”

Editor’s note: To contact Christine Hurt, call 217-333-7708; e-mail achurt@illinois.edu.