July 2002

Attorney General Addresses the "Defining Down of Deviance" Across Professions

America is experiencing a crisis of accountability across many professions and industries, a prominent law enforcement official said at a recent Accountants Club of America luncheon.

Eliot Spitzer, the New York state attorney general, attributed a rise in corporate-level crimes and scandals to a phenomenon similar to that of the rise in street-level crimes in the late 1980s and early 1990s.

"We were changing our idea of what is acceptable to avoid our obligations. For street crimes, it was defining deviancy down," said Spitzer, referring to a term used by former Sen. Patrick Moynihan (D-N.Y.) to describe a permissiveness in our culture he said spurred a crime wave near the end of the 20th century. "It's the same in corporate accounting. What began as an off-balance sheet became many (off-balance sheets). But it's not just in accounting; it's everywhere. Unacceptable behavior became acceptable."

Spitzer challenged the dozens of attendees of the June 3 meeting in Manhattan to consider how to reverse a widespread slackening of "standards of behavior." In discussing cases like the recent Merrill Lynch fiasco-in which analysts allegedly recommended stocks they privately condemned-the attorney general pondered whether the law alone could stem the seemingly continuous erosion of standards in "every sector of society," including government, not-for-profit organizations and the corporate universe.

"There has been a generalized decline in the standard of behavior in those people in leadership positions," Spitzer said. "My…challenge to you is, how do we resuscitate standards of behavior?"

Spitzer said the law can help, but he also said an overall "structural" change might be needed to correct things like the loss of trust in the financial markets. For the accounting profession, Spitzer suggested that industry self-regulation was inadequate. "I don't think it's an either-or question," Spitzer said, responding to an audience member's question of whether governmental or private regulation is the answer to recent problems in the profession. "But we have evidence that self-regulation will not be rigorous enough. We need both. We need enforcement so that the behavior comes down to a good standard of conduct."

But Spitzer also sees problems in public regulation, as illustrated in the recent Merrill Lynch case. Spitzer said his office pursued the case because there was a vacuum left by absentee regulatory bodies, like the U.S. Securities and Exchange Commission. The case centered on what Spitzer's office said was a blurred line between the firm's putatively independent research analysts and its investment banking division. Merrill Lynch analysts allegedly recommended stock in corporate clients of the firm's investment banking division even when they supposedly knew the stocks were not a good investment. Many people familiar with the industry had been aware of this arrangement for years, Spitzer said.

"Why the attorney general? Nobody else was doing it. Laws were in place…(but) there was a failure to act," he said.

The office investigated thousands of pieces of evidence, such as internal documents and e-mails. Spitzer said that when they found enough proof, they approached the firm to spare it the negative publicity.

"When we began we didn't doubt our theory was correct. Everybody knew what was going on. It was an accepted fact," Spitzer said. "My reaction (when they uncovered evidence in e-mail) was surprise that they were as blatant as they were. I was shocked that they were brazen, and disappointed: I tried to resolve this before it was put out to the public and they refused. Once we released the e-mails, they suffered a shock to their reputation."

The investigation resulted in a settlement requiring the firm to pay a $100 million penalty and sever the link between compensation for analysts and investment banking, among other reforms. Spitzer, in a statement on the attorney general's website, said this was an example of real reform, which is the key to restoring investor confidence.

In regard to Enron and Andersen, one audience member said that pursuit of structural change didn't seem fair: when a person commits any other crime, people don't call for a change in the law. Spitzer said he didn't see recent calls for changes in regulating the accounting profession as the first response to the Enron case, but that discussions of reform had been going on for some period.

"The Enron debacle was a catalyst that forced the subject more rapidly," he said. "With Merrill, we did a factual examination of individual problems first, then moved to a structural policy change. Sometimes structural solutions are better in the long run."