A couple of months ago, this post noted Wall Street Journal columnist George Melloan‘s op-ed on the Supreme Court’s Andersen decision in which he harshly criticized the government’s abuse of the rule of law to pursue currently unpopular businesspeople. Today, in this WSJ ($) Global View column, Mr. Melloan focuses on a common subject of this blog — the unjust nature of criminalizing corporate agency costs.
Mr. Melloan’s column focuses on the agency cost of corporate accounting:

Corporate accounting, contrary to popular belief, is chock-full of judgment calls. It’s a happy hunting ground for a prosecutor looking for decisions he can say were intended to mislead investors and might thus constitute criminal fraud. If an admiring press rewards him with a big headline, who’s to know, . . ?

Mr. Melloan then points out how prosecutors play to public bias in frightening boards of directors and executives into submission:

The frightened AIG board played into Mr. Spitzer’s hands by summarily firing Mr. Greenberg and ordering a five-year review of AIG financial statements. The restatement reduced stockholder equity by a net $2.264 billion. How could the earlier results reported have been that far off? A credulous public is likely to suspect that Mr. Greenberg was guilty — of something.

But corporate accounting is not a black and white world, notes Mr. Melloan:

But most people don’t know how flexible corporate accounting can be, particularly in an insurance company. At AIG, the auditors and some of the executives who furnished the restatement had produced the very reports they were revising. AIG operates in 130 countries and conducts “tens of millions” of transactions every year. Restatements in such a complex world aren’t extraordinary, for reasons, like honest mistakes, that are not criminal in nature. Merely adjusting the amount of earnings set aside for loss reserves — a judgment call based on guesses about what damage the future holds — can make a world of difference. . .
Accountants’ views on such matters may differ widely, but one or the other conclusion does not necessarily imply intent to defraud. Indeed, accounting is a profession well known among its insiders for its uncertainties and ambiguities. When the outside auditors of American companies sign off on a financial report, they don’t claim infallibility.

In closing, Mr. Melloan notes the dire consequences of this criminalization policy, including one that has been common in the case of Enron — the bludgeoning of executives into plea bargains by threatening effective life sentences if the executive risks defending his or her actions in court:

Another troubling sign . . . is that companies are fleeing from the court system, convinced that it is better to plea bargain with an aggressive prosecutor than to risk a jury trial. “Going to trial has become too risky for too many corporations because so many aspects are stacked against defendants . . .,” says Exxon-Mobil Chief Counsel Charles W. Matthews, Jr., . .
What this suggests is that the American legal system is itself breaking down under the burden of too much rule making and litigation aimed at raiding the deep pockets of business corporations. . . It would be nice to think that this will bring better decisions and greater transparency of benefit to investors. But what it looks like now is just a lot more money — a lot more — for lawyers and accountants.

For another case study in the syndrome that Mr. Melloan identifies, note this post and related posts referred to therein on the prosecution of the four Merrill Lynch defendants in the Enron-related Nigerian Barge case.