Capitalisn’t: Too Big to Jail

Kate: Luigi, now that you’ve been stuck inside for a while, you always talk about how you never watch TV, but have you finally watched a TV show? And, by the way, watching the news doesn’t count.

Luigi: Actually, yes, I admit I watched two. One series is The Loudest Voice. It is the history of Fox News with Russell Crowe in the role of Roger Ailes. He’s absolutely fantastic. It’s both very well acted and super interesting. And then I watched a different series called The Mechanism. It’s a Brazilian series about the Lava Jato investigation.

Kate: Oh, cool.

Luigi: The acting is not at the same level, so it’s a completely different cup of tea, but it’s very well done. And, actually, it might lead naturally to discussing today’s episode, because Lava Jato is about corruption in major companies in Brazil and how much the Brazilian government is involved in the corruption or involved in preventing the prosecutors from doing their jobs, and so on and so forth.

In America, we think this happens only in developing countries, that America is pure, and the US attorney general is a superior human being. What we’re going to discuss today is that maybe it is not as shiny as it looks.

Kate: Well, maybe one of the reasons that Americans have more faith in our justice system is that we don’t really get to see the inner workings of how corporations pull the levers of influence every day. But thanks to an excellent piece by ProPublica, we’ve gotten the inside scoop on how Walmart has been fighting regulators to avoid being indicted for its role in the opioid crisis. And so, that’s what we’re going to be talking about on today’s episode.

Luigi: This week, the US attorney general for Texas, Joe Brown, resigned. He did not mention Walmart in his resignation, but in the letter, there was a pretty clear statement that said, we must win the fight against opioid abuse in order to save our country. But in order to be effective, we must be willing to prosecute all facets of the expansive network that feeds these destructive drugs into our community. Players both big and small must meet equal justice under the law.

Kate: From Georgetown University, this is Kate Waldock.

Luigi: And from the University of Chicago, this is Luigi Zingales.

Kate: You’re listening to Capitalisn’t, a podcast about what’s working in capitalism today.

Luigi: And, most importantly, what isn’t.

Kate: The backdrop of this case has to do with the opioid crisis. And we’ve talked about the opioid crisis before on this podcast. When we covered it, we were mostly focusing on the role of the pharmaceutical companies and the doctors. We touched on, but didn’t spend too much time talking about, pharmacies themselves. But if you think about it, pharmacies that provide prescription drugs are the ones who distribute the drugs. They have a duty to their customers to fill prescriptions in a responsible way. And they’re also bound by certain laws to make sure that they are not being irresponsible in the drugs that they dispense.

Luigi: What is very important in understanding this case, as pointed out by the ProPublica article, is that several years ago Walmart had signed a memorandum of agreement with the DEA because of being accused of wrongdoing in the distribution of opioids and other prescription drugs. As a result, they reached a settlement in which they promised to improve their controls over the abuse of opioid prescriptions. So, that’s the background in which this takes place.

The case starts in late 2016 and is related to two doctors, Diamond and Wade. They both have been convicted, one to 10 years in prison and the other to 20 years in prison, for overprescribing opioids. The question is, to what extent was the Walmart compliance system able and willing to block people like Diamond and Wade? Eventually, Walmart blocked Diamond in March 2017, but after the federal investigation had started. In the meantime, he prescribed 13,000 controlled-substance prescriptions for an average of 11 a day.

Kate: You might be thinking, how does Walmart have any blame in this? This guy Diamond, this doctor, was the one who is writing these prescriptions. And Walmart was just listening to the doctor. But if you’re a pharmacist who’s dispensing these prescriptions, and you are on average filling 11 per day, you’re going to start noticing that this is a large quantity, and it might raise a red flag for you. And pharmacists have the ability to refuse to fill a prescription if they think that there’s abuse of a drug involved. And, in fact, many of Walmart’s pharmacists were doing this. Part of the memorandum of agreement with the DEA was that Walmart was supposed to be providing this information to the DEA so that the DEA would be able to pick up on these abusive doctors.

And so, it’s not like Walmart didn’t know what was going on, right? They had explicit internal systems in place as part of their agreement to cooperate with the feds, to monitor this sort of thing. And yet, in this period under which they were covered by the agreement, they were still dispensing these many drugs. So, the Eastern District of Texas, even though they started out with a case against two specific doctors, they uncovered a lot of information and became increasingly involved in this investigation that they decided to then target towards Walmart.

Now, what was Walmart arguing this whole time? They claimed that this was just a ransom. That it was an attempt by these attorneys and prosecutors in the Eastern District of Texas to extract money from Walmart to maybe build up some personal fame. I mean, after all, the government approved the sale of opioids. Opioids, as long as they were prescribed by doctors, were legal. And so, it wasn’t really fair for these prosecutors to be going after Walmart. Walmart was essentially claiming that this is a shakedown, that they weren’t really responsible for doing something that is legal.

Luigi: Yeah, this is typically the attitude that most large companies use when they’re attacked. They have two lines of defense. The first one is that it’s a bad employee. They tend to dump all the responsibility on the bad employee. Or they say, this is a conspiracy against us. They generally accuse wackos of believing in a conspiracy theory, but they are very happy to embrace it. This is a conspiracy because we’re big, we’re famous, and so, very aggressive US attorneys want to build their reputation and their fame by going after the big companies.

And there’s no question that there are cases like this. It is not past me to think that some attorney generals might exaggerate a case because of the potential benefits that they see or because of a natural dislike for large businesses, like many lawyers have. But what is remarkable about this case is that Joe Brown was a Trump appointee. It’s very hard to imagine that a Trump appointee has this particular vendetta against a large corporation.

Kate: What I found really interesting about this case is that I think ProPublica did a great job of outlining all of the ways in which Walmart was able to sort of shape-shift and move away and sneak away, and in some cases be really aggressive towards the government and end up essentially dodging regulators. The case is still ongoing, and negotiations are still ongoing, but for the most part, they have been pretty successful in evading these prosecutors in the Eastern District of Texas. What we want to do is to outline these various strategies and also to outline the benefits that are conferred to corporations by our legal system itself.

One of these comes from the top, the attorney general’s office. And actually, it isn’t an idea that Bill Barr has put forward. It was something that was popularized by Eric Holder. This is the idea of a deferred-prosecution agreement. If regulators at the federal level want to pursue charges—usually criminal, but sometimes civil—against a corporation, they can do so. They can indict that corporation or, alternatively, they can seek a deferred-prosecution agreement, which is kind of like probation. It’s kind of like the government saying, we’re going to come after you in three years if you don’t comply with what we want you to comply with. But, look, if you’re good for that three-year period, we’ll drop the charges, and you don’t need to worry about it.

Luigi: But generally, dropping the charges also comes with some money involved, so that the attorney general can show off that they got a big fine. The CEO generally blames the previous CEO for that and charges that against the earnings, but then says, oh, it is not my responsibility. And at the end of the day, you and I are the ones who really pay for this, Kate, because we are shareholders through our index funds in Walmart. It’s impossible not to be shareholders in Walmart if you own any index funds. The return on the stock is going to be affected by the fact that they paid a big fine to the prosecutor. And so, there is this kind of nice understanding between large corporations and prosecutors. They play this game. At the end of the day, nobody goes to jail, nothing changes. The only thing that changes is that you and I are poorer.

Kate: Not only are we poorer through our retirement holdings, but we’re also made worse off if incentives aren’t aligned properly, right? If managers at large companies aren’t scared of ever having to go to jail or aren’t scared of actually having to go to trial, then they’re potentially going to continue the wrongdoing.

Luigi: This is known in jargon as “too big to jail.”

Kate: I like that.

Luigi: Large corporations are so important, they cannot be punished. This, in a sense, is a backlash after the criminal prosecution of Arthur Andersen for obstruction of justice. That criminal prosecution led to the demise of Arthur Andersen, and it was later reversed at the Supreme Court level. And so, people say it is very dangerous to attack corporations, because you can create damage even before you’re sure that you’re right in creating this damage. That led to an overreaction that started in the Obama years, in the sense that prosecution, white-collar prosecution, dropped dramatically during the Obama years, but it also continued to drop even more under the Trump administration. In fact, we are at a 30-year low in criminal prosecution of white-collar crime.

Kate: So, what specific strategies did Walmart take to wriggle out from under the potential charges that they faced? Number one is to control the narrative. In the very beginning, there was this memorandum of agreement between Walmart and the DEA. Walmart was supposed to send the DEA all of these records of pharmacists who refuse to fill various drug orders, various prescription orders. Now, they did do that, but they didn’t include all of the notes that they were supposed to, or the notes that the pharmacists put in these orders for why they were not filling them. In essence, even though Walmart had come to this agreement with the DEA, they were supposed to turn over information, but they had control over how much information they were able to turn over. And they decided not to release the full amount.

Luigi: This is a bit of a game of chicken, because every defendant tries to use some strategy. But if I am a small company—my favorite one is Chuck E. Cheese—

Kate: That’s so random.

Luigi: —and I am accused or I’m under investigation by the Department of Justice, I’m terrified to be criminally indicted for obstruction of justice. And so, in the game of how close I go to the line, I’m pretty sure that I stay very far from the line, because for me, Chuck E. Cheese, a criminal indictment is the end of my business.

But if you are Walmart, especially after the Arthur Andersen case, you know you’re not going to be criminally indicted for obstruction of justice, and so you can push to the line, past the line. We let the judges decide where the line is, but clearly, as an economist, we can say very easily that your incentives are dramatically different than the incentives of Chuck E. Cheese. You can get away with much more than Chuck E. Cheese.

Kate: The second thing is deny, deny, deny. This isn’t something that’s specific to corporations. This is something that we learned as kids, when our parents get mad at us for drawing on the wall with crayons or something, but it’s a strategy that corporations also use when they’re up against prosecutors. Even though Walmart did sort of shift their strategy at some point in this case, remember that there were a couple of doctors who were basically running pill mills, and originally Walmart was hesitant to impose a blacklist on these doctors. Eventually, once those doctors were being investigated, they switched their strategy and did impose a sort of blacklist, or what’s called a corporate block. Even though they switched their strategy, they never admitted any wrongdoing.

Luigi: But if you are a parent, at least as a parent, I had a rule that if my kids did something wrong and they immediately admitted it, they were punished very lightly. If they denied it, and then I discovered they did it, they would be punished very severely. I think it worked because my kids were pretty honest in reporting. And I think that you should have the same rule. In practice, we do have the same rule that if you admit right away, there is some form of reduced sentencing. But if you are Walmart and you know you can basically pull this off as long as you can, you have no incentive to come forward quickly and admit it, because you know that the other strategy works better.

Kate: Not only that, I think this is kind of where it gets tricky for a big company like Walmart. Let’s say they had abused their power when it came to dispensing opioids. What happens if that comes to light? Is there a single case that the United States brings against Walmart? Potentially, no. There could be individual cases brought by individual states, in this case, the Eastern District of Texas. There could be class-action lawsuits that are brought against you. There could be civil versus criminal cases. There are all sorts of different cases that can be brought against a company like Walmart.

And so, if they admit wrongdoing in one case, it actually makes the potential for their liabilities associated with that wrongdoing much larger, because then the other plaintiffs in the other cases can say, look, they already admitted the wrongdoing in that other case, and that makes their arguments easier to make. And so, in some sense, the incentives are not very well aligned when it comes to our prosecutorial system.

Luigi: It is as if you had many parents, and they did not agree on the strategy, and you confessed to one and the other punished you brutally.

Kate: Exactly. Yeah.

Luigi: But, of course, one of the strategies that works the best is to hire prominent attorneys that are well connected with the administration. In fact, the irony is that, most of the time, the attorneys the large corporations hire are former US attorneys that made their name by going after large corporations and then make the money by defending large corporations. The revolving door at the Department of Justice, on the one hand, ensures that you have talented people at the US attorney’s office, even if you don’t pay very much. But, on the other hand, it really undermines the willingness of US attorneys to be too tough. They want to develop a reputation to investigate, but also not really to destroy a company, because do you really think you’re going to be hired by Walmart after you destroy another company like Walmart?

Kate: Well, actually, Walmart’s own internal counsel included a former US attorney for the Western District of Arkansas, who actually prosecuted a Walmart insider successfully. And so, in some sense, he was rewarded for taking a hard stance against Walmart, but Walmart was smart, and they knew that if they could get the best prosecutor to win a case against them, then that that person would also be the best person to prevent future cases from being won against them.

Luigi: And this is actually one of the important matters of disagreement in the discussion, the literature about revolving doors, because some people say that these revolving doors create the right incentives. If, indeed, Walmart hires the toughest people that did the worst damage to Walmart as their own legal counsel, that creates very strong incentives for US attorneys to go after Walmart. On the other hand, when they step down from US attorney to go and work for Walmart, if that makes them more lenient to a large corporation, that’s a disaster. And I fear the second hypothesis is more likely than the first, but there is a disagreement in the literature.

Kate: In this case, Walmart has gone out and they’ve hired the best lawyers that money can buy, these very expensive lawyers. Then, what do they do? The next tactic is something that we have discussed on this podcast before, when we were talking about the Business Roundtable decision. Jamie Dimon announces, “We no longer need to be so accountable to shareholders. We should be accountable to all stakeholders in the corporation.” And we talked on that episode about how it’s dangerous if corporations start talking about policing themselves, because then it takes the ability to police out of the hands of the government.

This is also something that Walmart did. Once they were alerted to these possible charges coming from the Eastern District of Texas, they announced that they’re running their own internal investigation. They were like, all right, you can stop looking at us, because we’re going to start investigating ourselves. And, lo and behold, they found no evidence of criminal wrongdoing. As the potential charges started to ramp up, they became more and more serious about taking their own internal steps aimed at opioid misuse. In fact, they even had Ivanka Trump visit one of their facilities very publicly to announce that Walmart is finally getting really, really serious about this. You don’t need to bring any criminal charges against Walmart, because we’ve got it all under control.

Luigi: I’m sorry if I keep using this analogy about kids, but it’s not a bad strategy with kids to say, you have to control yourself, basically self-regulate, but this is generally done under the shadow of a potential big punishment if you don’t. In the Walmart case, this becomes increasingly less likely, because they really pulled what I call the trump card.

Kate: The literal Trump card?

Luigi: The literal Trump card. This is to adopt the Trump strategy against the prosecutorial office. What is the Trump strategy? It is to question the motive of people coming after you. So, they start saying that the prosecutors were using the threat of criminal charges to extort a larger civil fine. This is a bit like when Trump started to question a judge because of his Hispanic origin and to ask whether he was independent and unbiased. Walmart started to question whether the US attorney’s office was unbiased. The funny thing is, if the US attorney’s office was appointed by Bernie Sanders, you might think that there might be some possibility of this, but the US attorney for the Eastern District of Texas was appointed by Trump himself. It’s very hard to imagine that a Trump appointee has this big agenda to destroy Walmart.

Kate: Now, another literal Donald Trump strategy to use is to make a mistake in language and to turn it against your enemy. An example that comes to mind for me is the case of Elizabeth Warren and the false claim about her background. Trump called her Pocahontas for, what, several months? Walmart did a less-intense version of this but something similar with a statement that was made in a private meeting.

To be clear, it’s not obvious what was said, but what the Texas prosecutors claim is that they said something along the lines that Walmart should be embarrassed for their actions. Walmart’s attorneys took this to say that the objective of the regulators, of the prosecutors, was to embarrass Walmart. And so, this word “embarrass” became twisted and convoluted. And they’re still kind of arguing about it. They’re still using it frequently, because if Walmart is able to successfully say, look, we got the prosecutors to admit that they were trying to embarrass us, then that just strengthens their own claim that this is really a personal agenda on the part of the prosecutors.

Luigi: Let’s be honest here, I think that filling 11 prescriptions a day by a guy who has been denied by most of the other pharmacies the right to fill prescriptions . . . it’s not like Walmart was alone in this. Many other companies received prescriptions filed by Dr. Diamond. Most of them denied those prescriptions. And Walmart kept doing it for years. If it’s not embarrassing, I don’t know what it is.

Kate: I mean, I should insert the claim, Walmart alleges that the government is unable to prove that any of those other pharmacies turned down those prescriptions, but according to ProPublica, they got some evidence that they were, in fact, being blocked.

Walmart, so far, has been taking a number of defensive strategies, like controlling the narrative and denying the wrongdoing and self-regulating. That, at some point, started to switch over to more-aggressive strategies, like claiming bias on the part of the prosecutors and exploiting this term “embarrassed.” At some point they were like, all right, look, let’s try to settle this. Let’s offer the prosecutors a little bit of money. And so, they offered $34 million to settle, which the Texas Eastern prosecutors considered basically offensive. It was an offensively small amount of money given what they viewed was the real damage from what Walmart did.

Luigi: And this is not the first time that Walmart got away with a small fine for a large, at least alleged, crime. During the Obama administration, Walmart was accused of bribing people in Mexico. And there was a New York Timesexposé of the investigation. The Obama officials were trying to settle for $600 million. Eventually, Walmart was able to settle for only $282 million, which, of course, for you and me, Kate, this seems like an enormous amount of money, but for Walmart is literally pocket change.

Kate: Yeah. If you think about it, there’s a lot of turnover in the justice system. There’s a lot of turnover among administrations. If, as a last resort, you, as a company, feel like you’re going to end up having to pay some money, then you should delay as long as you humanly can to pay that money, in the hopes that you end up having a more-favorable administration down the road. In fact, for these anticorruption battles, or, I guess, the charges of corruption originally brought by the Obama administration, Walmart ended up spending about $900 million in legal fees. That’s way more than they ended up paying in the settlement and also way more than what the Obama administration was seeking. But, in some sense, it’s a good strategy, because it prevents future charges being brought by other administrations or by different states. And so, this tactic of delaying and spending the money on lawyers, but not really being willing to pay out much in settlements, is in the long run a good tactic.

Luigi: This is very important, because most people, when they think about the term rent-seeking by corporations, they think about lobbying or campaign contributions, but the amount of money spent in lobbying and campaign contributions pales in comparison to the amount paid to lawyers to prevent this criminal indictment or civil indictment. $900 million in one year or a couple of years is an order of magnitude bigger than every lobbying effort that Walmart has done.

This is ultimately a form of rent-seeking. A huge amount of money is wasted from a societal point of view, because those lawyers are not producing something that is good for society overall, but they’re just producing a smaller penalty for somebody that might have violated the law. That is a huge waste. Not only is it a huge waste, it is also extremely unfair, because if I’m Chuck E. Cheese, number one, I don’t have the resources to do it, but most importantly, I don’t have the connections to do it successfully. And so, if I’m Chuck E. Cheese, I have to play by the rules. If I am Walmart, I can afford not to.

Kate: This connections point is kind of where things end up. Even though Walmart was willing to settle for a certain amount of money that was under negotiation, it ended up pissing off the lawyers in the Eastern District of Texas. And so, they continued to pursue these charges. Finally, as the last straw, Walmart called in its favors and called the people that they knew in Washington. What they did was that they had their Jones Day lawyer . . . Jones Day is a big white-shoe legal firm, which, for the sake of full disclosure, I have worked for before—

Luigi: You did?

Kate: —but only in a very minor capacity.

Luigi: Wow. You’re involved in the case, Kate.

Kate: No. I was a teaching assistant there, and I got paid a total of $3,000 over the course of several years of being a teaching assistant. I think that’s what one of their lawyers would probably bill Walmart for maybe 45 minutes. It was a tiny sum of money. I have no allegiances to Jones Day, but anyway, they’re very well connected. Walmart’s Jones Day lawyers sent a letter to the assistant attorney general, who was also head of the Department of Justice’s Criminal Division. Soon after, lo and behold, the DOJ allegedly ordered Texas Eastern to stand down and then, a couple of months later, told Walmart that they wouldn’t prosecute the company.

Luigi: At the end of the day, it looks like my Italian conspiracy theory is correct. US attorneys are appointed by the president. Certainly, the US attorney general is appointed by the president, and the president decides what he, most of the time—actually, all of the time, so far, it’s been he—wants to do. This creates perverse incentives. Number one, it creates a perverse incentive for a large corporation to be friends with the president so that they can get away with, literally, murder. That’s the connection between market power and political power that I’m very concerned about.

Kate: I think the connections are one part of the story but not the full story. There are a lot of perverse incentives here, right? There are perverse incentives to delay the case as long as possible. There are perverse incentives to never admit any wrongdoing because of the potential legal liabilities down the road. There are perverse incentives to switch strategies based on where they are in the case. There are perverse incentives to keep all of this out of the public eyes so that nobody ever knows what’s going on. The connections are part of it, but not everything.

Luigi: I agree with you that it is not the entire thing. However, as my repeated example of the parents suggests, if you operate under the shadow of the possibility of a big, big penalty, I think all these tactics might be reduced. If you know by experience, and this is why it’s learning by doing, because corporations try, and they see that they can get away with it, then they double the ante. If you eventually get punished big time, then you’re more careful.

But this is not just a US problem. Volkswagen had a defeat device to actually hide the performance of its diesel cars and the pollution of its diesel cars from the regulators. And, yes, one guy from Volkswagen was arrested in the United States, because he was so stupid as to actually go through Miami during a trip. But otherwise, nobody went to jail, and Volkswagen will pay, or has paid, some fines, but nothing really has changed. The problem is that more corporations are watching and learning. And so, the secret is, if I am too big to jail, I can get away with murder.

So, Kate, is this a capital-is or capitalisn’t?

Kate: I think this one’s pretty obvious. Walmart being, let’s say, I’m not using a legal term here, I’m just using my own words, somewhat negligent in dispensing opioids, which ultimately killed some people. That’s obviously a capitalisn’t. And their ability to get away with this, their ability to use their connections and their power over the legal system to get away with it, that’s obviously a capital-isn’t.

Now, I think another part of this, which is less clear to me about what’s the right solution, how we manage this, is a coordination issue on the part of the government. Between the states, between the federal government, even between different governments, between the US, between the EU. When we have huge multinational corporations, which are, as you’ve said, Luigi, too big to jail, how do we come up with a coordinated system to make sure that they face the right punishments and they face a coordinated set of regulators? This is a really difficult issue that I don’t know the answer to.

Luigi: Yeah. You’re absolutely right, Kate. The late political economist Allan Meltzer would say that capitalism without bankruptcy is like religion without sin. It doesn’t work. And I think that this doesn’t only apply to bankruptcy, it applies to punishment. I think that in order to have a good capitalist system, we need to have some rules in place, and these rules need to be respected.

We might disagree on how many rules should be in place, but I think we should all agree that the rules that are in place should be respected, because if we start to develop a system in which some rules are not followed, and in particular, bigger players can play by a different set of rules because they can not follow certain rules and get away with that—by contrast, if you’re a small company, then you have to follow the rules—then we distort the competitive game.

This is all a destruction of the very spirit of capitalism, where everybody is on equal footing. Many people say, oh, we shouldn’t punish large corporations, because they became large because they are efficient. And I turn this upside down and say, maybe they became large because they know that by being large, they can get away with murder. And so, they’re not more efficient. They’re actually creating more negative externalities. They make more money, but at a cost to all of us, at the cost of drug prescriptions being filled and people dying from those prescriptions because the proper compliance systems were not in place.