Video: Harvard Business School professor Eugene Soltes discusses his new book and explains why he considers white-collar crime to be a failure of intuition, not reasoning.

Eugene Soltes
Eugene Soltes

What drives white-collar criminals? Often, these are successful people who possess great wealth, have impeccable education, and hold much influence within their respective industries, yet they risk it all by breaking the law.

Eugene Soltes, the Jakurski Family Associate Professor of Business Administration at Harvard Business School, spent the last seven years speaking to and corresponding with nearly 50 prominent executives convicted of financial crimes, among them convicted Ponzi fraudsters Bernie Madoff and Allen Stanford, in attempt to answer this very question. He has spent years emailing, corresponding, and speaking to his subjects, visiting some of them in prison, even meeting them and their families, all in attempt to understand what separates honest, hardworking executives from those who choose to commit fraud or other white-collar crimes.

The result of Soltes’ many frank conversations with white-collar criminals is the book Why They Do It: Inside the Mind of the White-Collar Criminal (Public Affairs, 2016). Originally an idea that came to him nearly a decade ago, while still a PhD student at the University of Chicago Booth School of Business, the book provides an intimate peek into the mind of some of the most infamous financial criminals of their generation. It also allows Soltes to posit his own arguments regarding what drives white-collar criminals to break the law.

White-collar crime, Soltes argues, is not necessarily different than other forms of criminality. Much of it has to do with the environment in which white-collar criminals operate, and the incentives they are given. Decisions to engage in criminality are made just like any other decision: as a result of pressure, intuition, and failure to see the harm.

Incentives specifically play a big role in fostering white-collar crime, according to Soltes, especially when financial managers are pressured to succeed and have to make rapid decisions one after the other, their potential victims far from view. “I was doing exactly what I was incentivized to do. We wouldn’t have gone through all this trouble if we just wanted to cheat,” says Enron CFO Andrew Fastow in the book.

Soltes visited the Stigler Center on October 24 to give a talk about his project and findings. Prior to his visit, he gave an interview for ProMarket about the causes and potential solutions to executive failure.

Guy Rolnik: Why did you decide to write the book? You are a finance and accounting professor, what drew your attention, time, and energy to white-collar criminals?

Eugene Soltes: The project began when I was still a student in the University of Chicago and doing my PhD. One night while I was working on my dissertation, late in the evening, running some regressions, I was struggling to stay awake and actually was flipping through the TV channels, and I came across a show called MSNBC Lockup. It’s a cross between a documentary show and a reality TV show. Those people on the show were all violent offendersrape, murder, assault.

As a financial economist, I was just thinking about the people I read about in the news, Enron, WorldCom, Computer Associates. These were very much in the news at the time. So I just decided during my next 30 minute little pause, in between running regressions, I would just write them some letters and see what they had to say, just to see how they would respond to the same type of questions they were getting on that show. So it was personal curiosity. There was no scholarly endeavor, just personal interest. I went back to my dissertation. Then a couple of months later I started to receive some letters.

Dennis Kozlowski, CEO of Tyco, said, “I’d be happy to talk. Come visit me.” Stephen Richards, the former head of Computer Associates, sent me this really elegant eight page letter, in this cursive script, describing his experience. Which, I didn’t do anything with immediately. Then when I joined Harvard Business School, I ended up writing a case using this.

GR: What was your job market paper about?

ES: Actually it was on media and dissemination. It was how dissemination of stories by the media, the pure dissemination effect, affects things like volatility, cost to capital, liquidity. Nine million observations, the kind of traditional technical empirical work. I still think of myself as an empirical researcher. This entire project was very, very different. It’s one that, after I joined Harvard Business School, kind of was always in the background. After I wrote this first case I just started talking to some of these guys more.

I took them up on their offer. Just started visiting them, started writing back and forth, started having conversations at night. Slowly but surely, as you start with one or two people, there’s something fascinating about seeing these individuals. The kinds of individuals that we see on the cover of Fortune, on TV, and that come to business schools and give commencement addresses. We write cases about them. We learn and want to pattern ourselves after them when they’re doing well. When these failures occur, they disappear. We never hear from them again.

There’s something totally different than doing an empirical project, where the data’s this abstract amorphous thing that’s far and distant. This is very intimate, very personal. It drew me in. That’s how I ended up spending a lot more time [on it] and that ended up leading to this book.

GR: What kind of empirical and theoretical work can we draw from these personal stories?

ES: One of the main challenges that academics face studying fraud is that we don’t have personal information. We study firms. I think this is one of the major problems on fraud.

We always think about it at the firm level, what’s going on, rather than the individuals. Firms don’t cause fraud, despite the fact that they’re often fined very heavily because of it. Individuals cause fraud. You can’t get that kind of granular detail to investigate that.

I am starting to do some empirical work with some interesting data that I’ve developed some relationships with regulators about. It can’t investigate in that level of detail the underlying psychology. Why these extraordinary people, brilliant people, end up doing things that create this tremendous harm.

It’s hard to do that with empirical data that you can get in the field. The people who do this well, people like Francesca Gino, Dan Ariely. They do some amazing work related to fraud, but that’s in a lab.

I am trying to bridge that gap; trying to take the kind of work that some of the behavioral ethicists and psychologists have done in the lab, and try to think about when some of those biases we see might be operating actually in the executive suite with all these complex institutions operating around.

My strength, as an economist with a finance and accounting background, is to understand institutions. With a psychologist’s background they understand psychology very well. I am trying to bridge this gap. Those are very, very different sets of knowledge and skills.

GR: How different is the way you look at white-collar criminals, from the idea you had in mind when you started this project?

ES: I approached this like someone who comes out of grad school or as empirical researcher might; I took what we think of models, economic models, particularly coming out of the Chicago school. Gary Becker was one of my professors. There was this general model, and it’s what prosecutors say, that executives are making this careful, costbenefit calculation. This is what prosecutors say these people are doing and they are wellpositioned to understand this. Maybe I’ll better understand. Maybe they see that the benefits are sufficiently high. Maybe they just don’t think they’re going to get caught.

GR: So you started this project with the Gary Becker approach?

ES: Gary Becker and Milton Friedman wer
e actually very careful in their original work that their models were simply models. They’re mathematical models to predict behavior. They weren’t supposed to be models of the psychology. When criminologists started writing about it, when prosecutors, when people in the legal community started talking, they started transforming it from a mathematical model to a model of psychology–as if this is how people actually make these calculations.

I approached it like that initially. What was very, I’ll say, frustrating is that, despite whatever I could do to try to dig a little bit farther, I wasn’t finding that kind of behavior in the decision making process. They didn’t look particularly reflective in most instances.

A good example is Sam Waksal, the former head of ImClone. This is a brilliant guy. Ultimately, when he was sentenced and he was in prison, he was reading Nature and Science in prison every week. He’s an academic, but also an executive.

In his case, he received some negative test results. He reacted, and called his daughter, and told her to dump her ImClone shares. The guy at the time was worth hundreds of millions of dollars. His daughter had a couple million dollars in shares.

This is about the stupidest kind of fraud one could do. Calling your family member and telling them to dump their shares after you’ve just received some bad news is the stuff that, this isn’t even hard for the regulators to pick up on. This is stuff that’s routinely monitored.

When you look at his decision to call his daughter to dump her shares, we might be able to come up with some elaborate mathematical model to depict how one could predict that might occur, but that doesn’t represent the psychology very well.

As he says, he’s at a loss to explain why he would do something like that, because it’s just so noncharacteristic. This is what led me to think about this. These aren’t failures of reasoning. These seem to be much more failures of intuition.

How I thought about this in a more general way is, knowing the difference between right and wrong is not sufficient to stop one from going ahead. One needs to actually feel that what you’re doing is actually harmful.

That is what causes us to not proceed. Put differently, I spent a lot of time with these guys. I was never worried about one of them coming up, stealing my wallet, and taking the money out of it.

And why not? They’re social. In order to steal my wallet they would have to come up to me, to touch me. It’s physical. They would see my reaction. Simultaneously, many of these people have implicitly taken actually much more money from me–because I had investments in their firms.

They don’t feel there was anything particularly harmful in that. This is why a guy that would never be willing to steal $5 from my wallet is willing to steal $5,000 from my retirement account. It’s saying that there’s actually something different about these white-collar crimes that are more distant, and more abstract.

GR: When you say “intuitions” and not “reasoning”–do you think that this is where the norms in the community come in? They are shaping those intuitions?

ES: When we look at some of the most, I think, spectacular and surprising cases of executive failure. I would say most prominently the executives from McKinsey & Company, Rajat Gupta and Anil Kumar. Scott London, a very senior partner at KPMG.

In order to get to the rank in the firm partner level, in the case of Rajat Gupta the head of McKinsey, that’s not by luck. You’ve spent decades, literally decades, practicing and preaching many of these values. Things like confidentiality–that I don’t even tell my spouse what I’m dealing with, I don’t talk about clients in the elevator.

When you look at these couple of cases you see that their interaction with someone external, someone with a very different set of norms than what they do within McKinsey, within KPMG, you see them doing something that’s entirely counter to those values.

The kinds of values that we shouldn’t physically harm someone. Those are things that we can be deeply rooted. I try to make the argument that we have some things that we’re deeply rooted, to not want to cause physical harm to others.

That’s actually something we have to actually train ourselves, and the military does this, to basically counteract that force. When these harms are very, very distant, we have to basically create a new set of intuitions, a new set of norms, to try to have us appreciate those types of harms and actually realize that. This is something that firms try to do.

For example, you look at the training that goes on in a place like McKinsey; a place that has an extraordinary culture and a set of routines to try to preach and practice about how individuals at the firm ought to behave towards clients.

Very quickly, if you start interacting with someone that is different, even if you spent decades practicing that culture, that can quickly be undermined. I think that’s what we see with Rajat Gupta or Anil Kumar. After decades within McKinsey culture, they start spending time with someone in a hedgefund, a very different set of norms and culture. You quickly see, in some tragic way, how those norms that you learn to practice and develop over time were discarded. They adopted this new set, which is ultimately what led to them being undermined.

These kinds of new nonhardwired norms that we build within firms and their culture, they need to be continually reinforced. Otherwise we see them being discarded.

GR: Those convicted white-collar criminals that you interview for your book, how different are they from other executives?

ES: No doubt that a lot of corporate misconduct is a lot like speeding. There’s one guy that gets pulled over, but there’s three other people that were not in the red car. They got passed, but the guy in the red car is the one that gets pulled over.

That person might complain that, “that’s not fair because those other people were speeding,” but you still did it. There’s no doubt that’s the case. I think there are certainly other people. That said, I think one of the things which I’ve tried to argue is that the kind of failures that we see occurring at the executive level are not so different than the kinds of errors we are all susceptible to make. The main difference is that when an executive makes an error, his or her decisions now affect not only a couple people around them; it can affect tens of thousands, hundreds of thousands of investors and employees. That same error is just magnified so many more times. I think that’s the challeng
e of leadership. The people in those positions of leadership, they still have the same foibles and limitations that we all do. Except when they make an error, it’s much worse.

By and large, I think there are exceptions. I discuss Bernie Madoff, who I think is different in a number of ways. I’ll say that most of the prominent criminal executives I spoke with are much more similar to us than different. Much more similar to the kinds of people that we’re surrounded by: ambitious students, the kinds of successful executives I see in the paper today, or that we have visiting our classrooms.

GR: So, do we have bad apples or a rotten corporate cart?

ES: I think by and large these are the apples that got caught. I think the bad apple label, while it’s convenient and I think in some ways reassuring, we like to distance [ourselves]. It’s nice to feel the distance of these people and say, “we are not like them, I would never do what they do,” and to have that comfort that that would actually be the case.

I think that’s naive and just a lack of humility. It’s very easy for me to sit here and say, “I would never do what they did.” Naturally I think with my current norms and values, if I stepped into their situation, I would act differently, like most students and most other people.

The difference is you don’t get to bring in your current norms, values, your outlook, the people you’re surrounded by to make that decision. You would have to imagine doing their decision being brought up in their set of norms, under their pressures, with their set of incentives, with their background.

If one thinks about the question in that way, I think it’s a lot harder to be confident that you would undoubtedly respond differently. We’d like to believe so, and hopefully we would, but I don’t think we could know for certain.

GR: For some interesting reason, most of the white-collar criminals that you meet always think that there are people who are much worse, who got away with crime.

ES: That’s certainly the case. The SEC comes under a lot of scrutiny for this in their multiple settlements that bring no charges against executives. They neither admit nor deny if they committed the fraud.

They get to put a press release that says, “You committed fraud, but you neither admit nor deny that you committed fraud,” which they’ve, I think, been appropriately pushed back on, because what does that even mean?

As you point out, the people that did insider trading said, “You know what? This isn’t that bad, because at least I was building something successfully. It’s the guys that did financial fraud that are the real villains.”

If you talk to the guys that did financial fraud, they say, “You know what? At least I was trying to build something. It’s the guys that did Ponzi schemes that were bad because they weren’t building a business.”

Then you talk to the Ponzi scheme guys, and they say, “I might have lost a couple million, or even a billion, but it’s not as bad as the trillions of the dollars that the bankers that weren’t prosecuted destroyed.”

Where it’s not even an acknowledgment of a sense of, “well, I’m unlucky that I got caught, and other people didn’t,” but more genuinely  a sense of not actually deeply feeling in that visceral way that what you did was actually that harmful.

That’s what I found so interesting, and made sense after I spent enough time with these guys, is that we could intellectually depict that what they did was harmful.

They can understand as a class exercise how insider trading could distort this, this effect, and trace through how, if you commit fraud here, of how that eventually leads to someone having slightly lower earnings, or slightly lower dividends in the futures or the retirement account.

It’s an intellectual exercise that takes several minutes, or sometimes days, to go through. It’s not something you actually viscerally feel as being wrong and harmful. That’s the important distinction.

GR: Do you see any connection between illegal corruption and legal, institutional corruption–people influencing the rules of the game to their benefit?

ES: I think there are some, and this is what [motivated] some people like Senator Elizabeth Warren, and certainly Occupy Wall Street, that there are some systematic elements within business that are certainly not to be admired, and actually, I think we ought to be correctly worried about.

As I think in the broadest way, how many people in business actually look at what’s the distinction between right and wrong, how I ought to proceed, is we look at–legally–we talk to our lawyers. Our lawyers then look at the law, of what is technically lawful.

The problem is when we’re operating on a lot of these frontiers, this is exactly what Enron did, is they wanted to be super aggressive. In their case, I do believe they were trying to follow the rule of law in the most technical way possible.

That means when there are 15 rules in their way, what they did was first go to their set of attorneys, and then say, “Well, is there a way we can concoct a transaction that technically follows all these, but still gets around all of them?”

In the process, the spirit of the law has been entirely lost. And when that didn’t work, sometimes, then you just lobbied to have it changed.

The principle and the spirit of what you’re trying to do in the course of business is to build an enterprise that creates value, both for yourself, for shareholders, and for people more broadly–and this principle is entirely lost when you’re changing the rules or getting around them. 

GR: One of the stories that I liked in your book is why economic fraud was more difficult in the past; you bring the story from 1639 about Robert Keayne–a prominent merchant in New England who was price gouging and had to face his congregation with tears in his eyes and ask for forgiveness. This is a ritual that really can change norms in a community. And to think that his crime at the time was that he sold his goods with markups that left him with 100 to 150% profit margins. This was deemed as a crime in those years.

ES: This is the goal of any business. This could be a case study of what people are aspiring to. What’s pretty amazing when you think about that case is it was a crime, and he was a very prominent businessman at the time. When he was called out for this, not only was he sanctioned in the eyes of the law at the time but the whole community.

He had to face
all his social relationships, which was church, and beg forgiveness to the people in his community to forgive him for this.

Today it’s very different. Take the Wells Fargo case for example. You see the public at large up in arms as we have seen in the senate hearing–but you can be sure that the executives of those banks, most of the time, they live in an insular culture, they would argue that “Oh, this is a oneoff,” “a bad apple,” “this is isolated,” “this really isn’t that systematic.” Everyone takes their own camp.

If anything, the camp in the business side ends up trying to protect that this actually isn’t so bad. Rather than genuinely looking at it, saying that, “Maybe, actually, something’s wrong here.” When you have 5,000 employees, doing something that’s ultimately illicit, that’s not a oneoff event.

Actually, if anything, in the case of Wells Fargo–you’ve actually designed a pretty effective culture. It’s just that culture has actually led those employees to do something that’s wrong. Ultimately, it’s not clear who’s actually doing the sanctioning.

In the case of Wells Fargo, many of the recent cases, the firms are levied these extraordinary fines. Hundreds of millions, now we’re seeing billions and billions. Now to have a billion dollar fine is actually not that unusual or even spectacular. It’s not even front page news anymore. Who pays those fines?

GR: The shareholders.

ES: The shareholders are paying that.

GR: Some would argue that we are punishing the shareholders twice.

ES: Yes, you’re punishing the shareholders twice. Many times, the executives who are actually leading the firm are still there. That is, I find frustrating, that ultimately the people who ought to be held accountable for the actions ultimately generally are not. To the extent that this continues to occur again, and again, and again.

GR: Let’s use your Wells Fargo example. Is it possible that the corporate culture that allowed  employees to be involved in illegal practices might also be present in legal practices that harmed customers of the bank? Like selling customers un-needed or expensive financial products?

ES: That’s a great point. It looks like, in some of the cases with Wells Fargo, there were people doing things that were more bluntly illicit. Then there are also cases, and we see this in a lot of places, that people find a clever way of interpreting the laws to their advantage, where they look at some fine print, read a line in a very particular way that gives them some flexibility. 

You say, “Oh, well.” Clearly, you’re supposed to offer, and they’re supposed to sign up. You’re like, “Oh, we’re helping them, so we’re just going to give that to them.” They feel that gives them justification. That’s a rationalization.

You also could have potentially attorneys in some of these cases helping. Helping to facilitate a way that allows that line to be interpreted in a way [that allows them] to proceed. Uber is probably a cleaner example in this case, in which they’re one of the most celebrated, successful businesses of the 21st century.

But, let’s not ignore the fact that in many of the business jurisdictions they’re operating, they’re doing things that, in some places, have been deemed illegal, like in France. I think South Korea also. They’ve had significant pushback. It’s because they’ve taken regulation and reinterpreted what it means to have a license, or who can drive.

I’ll say this is what’s been this very acrimonious debate that they’re reinterpreting regulation as they and their attorneys see it. Some people agree that the regulations are outdated, so we need to update it, and they’re helping do that.

In other cases, people sayif we go to Franceyou could reinterpret that regulation in a way that’s not actually illegal.

GR: Uber in many ways is more of a regulation game than a technology company. They mastered regulation.

ES: Uber is indeed a case where the CEO explicitly said in the past that: we found clever and thoughtful ways of reinterpreting the laws in a way that they don’t apply to us. We’re not technically breaking it. It’s just not been addressed for this area.

GR: In your book you use Professor Luigi Zingales’ research on the cost of fraud on the US economy and you use the figure $400 billion a year. But you did not address the important question: does this figure represent transfer of wealth or inefficiency or both?

ES: That’s actually an interesting point. I’ll say, even if we were going to go on the extreme, it’s not pure transfer in that there’s a lot of, I would say, transactions costs associated with, to the extent any time we have cases of fraud and all of this, there’s massive, massive sets of transactions costs. The $400 billion, that can’t actually be a pure loss. It’s the other externalities which are even broader than this which would make that number even higher. Like the effects of cost of capital. If people actually didn’t believe the financial statements, they’re not going to be willing to invest in debt equity markets. To the extent that doesn’t happen, either we’ll lose those enterprises from ever coming into being, or people will choose less efficient sources of capital.

GR: You are a professor at Harvard Business School, and business schools come under fire in your book a few times as institutions that could do much more to prevent their students from becoming white-collar criminals. 

ES: Yes, one of the things I do wonder about in the book is why regulators, with the resources they have in their hands don’t succeed in preventing this criminal behavior. And this leads me to think maybe we should make firms take this fight against corruption and criminality more seriously. One of the ideas which I raised in the book is that business schools will ban companies who have been recently involved in criminal behavior from campuses on recruitment week. In the cases in which firms have been criminally prosecuted, admitted guilt, they would be deemed on probation by the universities. That we would say, for some period of time– not forever, but for the next two years, three years, while you’re changing your system, while you’re changing your culture–you’re not welcome to come on campus. You can still advertise with Google when you are hiring but not here on campus.

GR: That sounds like a very interesting idea, but you can imagine the backlash that business school
leadership will get from the large corporations involved.

ES: Well, that would be a success. If you’re getting the boards and executives to talk about this, and they’re seriously worried about this, that suggests that this has been far more effective than billions and billions of dollars of fines that they now pay in those settlements. What I am suggesting is–let’s have this conversation of whether the firms that come on campus, just the following week after they pleaded guilty for some money laundering to really terrible countries, whether they represent our values right now, and whether we should give them the privilege of coming on campus.

Maybe we decided that we don’t want to, but let’s have that conversation in our faculty meetings.

GR: In the book you feel the story of the whistleblower in ADM that exposed the illegal cartel of companies that fixed the prices of lysine for years, that it was his wife, not compliance that triggered his decision to expose the criminality.

ES: Compliance systems are viewed as technical laws. Compliance systems within firms are not looked at as inspirational. They’re looked at technical legal ways of protecting the firm, rather than as ways that people are really excited to protect themselves.

I actually think we almost need something more of a personal preservation framework, which isn’t compliance. There’s ways to try to make sure that we’re actually still being the type of person that we expect ourselves to be.

The slide that I show at the end of my lecture on white-collar criminals is all the Harvard alums that are currently sitting in prison. There’s roughly two dozen right now that have been recently in prison.

I show the slide and I tell them: “There’s not one student that’s about to graduate where you are right now that thinks that right now they’re going to  go out and make a pile of money, have a great family, be a leader of a kind of industry, and then after 30 years, let’s commit some fraud. Let’s engage in insider trading.”

That’s absurd. No one thinks that. If anything, they think the smarter they are, the less likely, they’re never going to get into that. But when we look at the data we see that some really extraordinarily talented people commit fraud. Let’s step back and think of why that happens, and what people can do about it. I don’t think technical compliance regulation is the way to solve it.

Even the white-collar criminals that I talked to, I genuinely believe that even when they were doing the most blatant kinds of fraud and manipulation, they still assess the probability that they were going to have a criminal sanction against them is very low. It’s nearly zero.

GR: This infallibility that you describe that characterizes many of those executives. Is it their compensation, their lifestyle, success, insularity?

ES: The compensation, the money is just a way to measure the success in the game, to keep count. Ultimately, when you start to get into some of these cases, though, it’s hard to see where money is actually linked.

There’s much more around prestige and reputation. Think of Enron. They wanted to create the world’s leading firm. They become wealthy, and they enjoyed the benefits associated with that wealth. If you were to give them the choice between wealth, and fame, and reputation once they hit some certain level, they would choose the reputation.

Even more broadly, even if the compensation was lower, you’re in such an insulated place. I give the example of Dennis Kozlowski. He would tell me: “The independent directors would give me anything I wanted.” You’re basically surrounded by people who are not there to critically push back on you. They’re there to nudge you.

GR: Do you think that the board of Tyco was a typical board?

ES: There were some very good people on that board. The trouble with boards, from talking to many directors on those boards, is that you’re there for a fairly limited amount of time. We’re talking a couple dozen hours so you don’t have any relationship that really enables you to deeply push back on the CEO.