Freedomnomics: Why the Free Market Works and Other Half-Baked Theories Don't (11 page)

I interviewed representatives from many of the biggest PACs about this topic.
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Most of them have rules forbidding double-giving; in the exceptional cases where they do double-give, it is almost always because one of their own members is a candidate. This held true whether the group was a trade, corporate, ideological, or labor PAC.

So where does this myth of widespread double-giving originate? Mostly, it comes from sloppiness in using the data, such as attributing corporate donations to the companies themselves rather than to their employees, as previously discussed. Additionally, double-giving is sometimes alleged when PACs simultaneously donate to both Democratic and Republican primaries. But this is not actually a case of double-giving, and there is nothing cynical about it; PACs simply seek to support candidates in both parties whose positions are closest to their own. And even in such instances, if the candidates supported by a PAC win both parties’ primaries, PACs almost always limit their donations to one candidate in the general election. Unfortunately, this kind of sloppy reporting helps breed a general animus toward the entire political system and generates demands for new campaign finance laws, which in turn create far more problems than they solve.

A commonly heard complaint about our criminal justice system is that it favors the rich over the poor. With their ability to hire high-priced attorneys, wealthy defendants can allegedly “buy” a favorable verdict or at least secure a minimal sentence if found guilty. Very few people would disagree that a rich defendant has an overwhelming advantage over a poor one. But when we analyze the overall consequences a criminal faces after conviction, we find a surprising result: rich criminals face disproportionately high penalties.
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When people think about how criminals get punished, they tend to focus on prison terms. Perhaps financial penalties also come to mind such as fines, restitution, and legal fees. But for many convicted criminals, the most significant penalty is something else—their lost reputation. And it is through the loss of reputation that the wealthy really pay for their crimes.

Let’s look at a statistical composite of two hypothetical people—in 1984, Jim made $17,000 per year working as a bank teller, while Brandon made $82,000 per year as a manager at the same bank. Aside from their jobs and income, both men are statistically identical—they are
unmarried, forty-year-old, white male Californians with no criminal history. Let’s say they were both convicted of committing the same crime—embezzling over $350,000 from the bank, the average amount stolen in these crimes.

According to statistics, their prison sentences would be very similar, with Jim spending around five weeks in jail, while the better-off Brandon would be locked up for five days less.

But the slightly shorter prison term is the only advantage that Brandon would receive from his wealth. On the downside, Brandon would face financial penalties far in excess of those applied to Jim. But the larger fine extracted from Brandon—$4,000 compared to $1,700 for Jim—is just the beginning. Brandon’s main punishment comes in the lost earnings after he returns to work. While Jim can expect his income to fall from $17,000 before his conviction to just over $10,000 afterward, Brandon’s income will plunge from $82,000 to a mere $4,700. Amazingly, after controlling for a variety of social and demographic factors, wealthier ex-convicts on average earn a
lower
salary after their conviction than poorer ex-convicts.

This crushing drop in income is especially evident with the richest ex-convicts. The average person convicted of insider trading in 1984 and 1985 made $365,000 a year prior to conviction versus $14,000 in the last year of probation or parole. If the legal costs and fines weren’t enough to bankrupt them, around two-thirds of white-collar criminals get divorced, with their spouses getting 90 percent or more of their assets. (The normal property division rules don’t apply when one spouse becomes a convicted felon.)
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Why would the conviction of a rich corporate executive depress his later income so dramatically? To begin with, after his conviction, he is highly unlikely to regain enough trust to be rehired to a job at his previous level. Although shareholders oversee the activities of a firm’s top officers, it is impossible for them to monitor all of their executives’ decisions. They must have some degree of trust in their officers’ honesty.
Although shareholders will probably learn of corrupt activities eventually, by then it may be too late to correct the problem. A CEO could embezzle huge amounts of money or do other irreversible damage to a company before his dishonesty is discovered.

For this reason, companies place a premium on their executives’ honesty.

They, like most Americans, see the terrible price paid by companies like Enron, Adelphia, Tyco, Imclone, and WorldCom due to the dishonesty of a few corporate executives. Despite the headlines generated by these scandals, however, it should be noted that the overwhelming majority of America’s 11,000-plus publicly traded firms are not run into the ground by their own corporate officers. Shareholders tend to find honest people to run their companies because it is in their own interests to do so.

This means they will be very hesitant to hire anyone with a criminal record. It is difficult enough to hide a criminal conviction, as probation or parole can last for years, and employers have to submit reports to an employee’s case officer. But it’s even harder for the wealthy to cover up a conviction; the richer and more powerful the man, the more publicity his trial is likely to receive, and thus the easier it is to discover his criminal past through something as simple as an internet search.

Even the relatively few rich ex-convicts who do secure a high-paying job after their conviction tend not to be successful. As Robert McCries, who studies the lives of indicted or convicted insider traders, notes, “Some of them do get back to [the securities industry], but they never shine with the luminance that they had during the time that they were previously operating. If they do re-enter the field, they find the community isn’t ready to support them. They just generally don’t do so well and after a period of time they tend to drop out ....People avoid them . . . .There are so many people to do business with, why must you do business with this person? That’s the kind of harsh questioning that is raised.”
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But how do we explain why rich ex-convicts’ incomes fall even lower than those of poorer ex-convicts? It’s because rich convicts not only get shut out of high-paying jobs, but they also have more difficulty finding lower-paying employment. Suppose that a successful lawyer is convicted of a crime and is disbarred. Unable to get hired to a different high-paying job due to his criminal record, he looks for a blue collar job. How would prospective employers view his application? Most likely, they’ll think he is vastly over-qualified, that he will quickly grow bored with the job, and that if he’s hired he will continue looking for a higher-paying job. The lawyer’s prestige and experience—the very things that made his resume so impressive—now work against him. If an employer of manual laborers had to choose between two convicted criminals, he would likely prefer one with a blue collar background to someone with vastly higher credentials. In the case of Robert Chest-man, a stock broker convicted of insider trading, his conviction made it so difficult to find work that he simply went to jail pending his appeal.
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Let’s look at the fate of Peter Bacanovic, a key player in what is perhaps the most highly-publicized white-collar crime prosecution of the last decade—the Martha Stewart case. Bacanovic was a stockbroker for both Martha Stewart and Samuel Waksal, the CEO of biopharmaceutical company ImClone. When the FDA refused to approve one of ImClone’s key drugs, Waksal and his daughter sold their own ImClone stock before the FDA decision became public. Informed by Bacanovic of Waksal’s stock sale, Stewart sold off her own ImClone stock. Although Waksal was eventually sentenced to over seven years in jail for insider training, neither Stewart nor Bacanovic were charged with any crime related to Stewart’s stock sale which, in the end, appears to have been legal. But they were both convicted of lying to regulators about the sale.

Bacanovic was sentenced to five months in prison and five months of home detention. This sentence was widely publicized in the press,
which rarely explored the additional penalties Bacanovic had to suffer due to his loss of reputation. Bacanovic was fired by Merrill Lynch in October 2002, when he was first charged, and has been unemployed for the four years since then.
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Furthermore, there is no chance that he can re-enter his former occupation, as he is barred for life from even associating with stockbrokers or investment advisers. It is also doubtful that he can ever obtain any type of professional license. His criminal and civil fines totaled $79,645—for lying about a stock sale that earned him all of $510.
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Like the case of Bacanovic, it is common, indeed usual, for people to lose their job as soon as they are charged with a crime. This tendency is not confined to companies, as borne out by the 2006 lacrosse rape scandal at Duke University. Three Duke lacrosse players were charged in April and May 2006 with raping a stripper during an off-campus party. Despite the players’ vehement denials, conflicting stories by the stripper, negative DNA tests, and accumulating evidence of misconduct by District Attorney Mike Nifong, the university suspended two of the players. (The third player had already graduated.) This is a common procedure at Duke for students charged with felonies.
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The suspension looked to be long-term, as it was expected that the trial might not commence for a year after the charges were filed.
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Meanwhile, with such a tarnished reputation, the odds of another prestigious university allowing the suspended players to transfer were nearly zero. One of the players, David Evans, had a job offer rescinded from J. P. Morgan.
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In January 2007, after Nifong dropped the rape charge and the North Carolina State Bar filed a complaint charging him with misconduct, the university allowed the players to re-enroll.
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The salient point here is that universities, like companies, rush to divest themselves of disreputable students or employees even before their crimes have been proven in court.
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One does not have to be a rich stock broker or a student at a top-ranked university to suffer severe reputational penalties from conviction.
Krishan Taneja, a civil engineer convicted of trading on illegal stock tips, spent six months in federal prison in 1979. After his release, his wife divorced him and his former employer refused to re-hire him. Broke and unemployed, he applied unsuccessfully for licenses to become a stockbroker, a real estate agent, and then an insurance salesman. Nine years later he was driving a yellow cab in New York City.
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Likewise, S.G. “Rudy” Ruderman, who broadcast
Business Week
’s daily market report, was convicted in 1988 of trading on stock tips before the tips appeared in the magazine. For a year-and-a-half after he left prison, he held a part-time job reading the news on a small Westchester, New York radio station. After that stint ended, he lived off his wife’s income.
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Aside from the loss of job and income, ex-convicts are likely to suffer from a variety of additional financial penalties that affect the wealthy more than the poor. These include being prevented from inheriting property, the partial or total divestment of assets, loss of life and/or car insurance, and the loss of pension funds, including the discontinuance of pension payments for ex-convicts who are already retired.
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In fact, presidential task forces have emphasized the importance of these collateral penalties and expressed concern that inattention to them will create inequities in criminal penalties.
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Of course, these penalties come on top of the loss of rights likely to be incurred by all ex-convicts regardless of their economic status, such as voting rights and parental rights, as well as the ability to serve as a juror, hold public office, and own firearms.
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Thus we see that once reputational penalties are considered, the wealthy tend to face significantly more punishment than the poor for committing the same crime. Since few people want to risk being perceived as sympathetic to white-collar criminals, however, reputational penalties are rarely mentioned in the public debate on the inequities of the judicial system.