An era of corporate-crime fighting is ending. What's to keep fraudsters from striking again? Fear, and a stock market stuck in neutral.
By Justin Fox

(FORTUNE Magazine) – THE NATIONAL SPASM OF OUTRAGE over corporate and Wall Street misbehavior is shuddering to an end. As has occurred after market meltdowns and big-money scandals since the dawn of time (or at least the dawn of American industrial capitalism), some bad guys were convicted, some reforms were enacted, and though public bitterness remains, the folks who make the rules seem ready to move on.

Other than Enron's Ken Lay and Jeff Skilling, who go on trial early next year, all the alleged corporate superfraudsters have had their day--months, really--in court. The Supreme Court has even overturned one guilty verdict, that of defunct accounting firm Arthur Andersen. New York attorney general Eliot Spitzer suffered his first big courtroom defeat in June and may be tempted to tone down his prosecutorial zeal as he prepares to run for governor. And on Capitol Hill, the days of corporate reform are clearly past, and the chairman-designate of the Securities and Exchange Commission is regulation-averse Congressman Christopher Cox (R-California).

So it's fair to ask if the frenzied activity of the past three years has changed anything. Have the interests of the bamboozled and defrauded investor class been served? Is it safe to get back in the market?

It certainly seems safer than it was in 1999. With WorldCom's Bernie Ebbers headed for prison, AIG's Hank Greenberg forced from office, and other former business titans cast to similar fates, fear should get the better of would-be wrongdoers and even envelope pushers, at least for a few years. But such memories always fade: For all of Spitzer's success in changing behavior in the brokerage, mutual fund, and insurance industries, one suspects that his most durable legacy will be that nobody in the financial services business will ever again say anything of consequence in an e-mail.

Laws and regulations can have a more lasting impact. The Federal Reserve and the SEC are both products of congressional reactions to market meltdowns. The Public Company Accounting Oversight Board, the main institution created by the 2002 Sarbanes-Oxley Act, is no SEC or Fed. But there is a chance that Sarbanes-Oxley's provisions will keep accounting firms slightly more honest and make it harder for the future Richard Scrushys of the world to claim that they had no idea their underlings were cooking the books.

Don't expect much more than that, though. The belief that legislators, regulators, and judges can somehow put an end to corporate wrongdoing is persistent but mistaken. "My wife is a biochemist trying to find a cure for cancer," says Stanford law professor and former SEC commissioner Joseph Grundfest. "I'm a lawyer trying to end securities fraud. She's going to succeed before I do.... It is human nature at some point in commercial dealings to go too far, to try to take advantage."

Another law professor, Harvard's Mark Roe, offers a more specific theory to explain what he calls "the inevitable instability of American corporate governance." Roe argues that American corporations are run and regulated in a manner fraught with conflicts, loopholes, and perverse incentives--golden parachutes, anyone?--that can't, or at least won't, be legislated or regulated away because they are intrinsic to our way of doing business.

The core conflict is the separation of ownership and control. The shareholders of your typical large corporation are a dispersed, distracted lot without the time, inclination, or expertise to run the company. That leaves day-to-day control of the corporation to its managers. On the whole, this has been a spectacularly successful formula. But it means that when the people who run companies decide to do things that aren't in the interest of shareholders--make self-aggrandizing acquisitions, raise their own pay, falsify earnings statements, buy $6,000 shower curtains with company money--those shareholders are usually not in a position to do anything about it.

This reality was spelled out in detail in a famous 1933 book by Adolf Berle and Gardiner Means, The Modern Corporation and Private Property, which helped motivate Congress to create a government agency--the SEC--to do what shareholders apparently could not. But the SEC shares authority with a patchwork of state and federal regulators that savvy executives can play off against one another and against Congress to get what they want. This porous structure can sometimes be a good thing in that it constrains overzealous regulators. But it can also be an enabler of great mischief.

It is when the stock market is booming that the potential for mischief is greatest: Shareholders don't ask difficult questions of the CEOs who appear to be making them rich, and regulators encounter squeals of resistance (and threats from Congress) if they try to crash the party. It is the years of disappointing market gains that usually follow a boom that may do the most to improve corporate behavior: Managers have to focus on creating real value to keep shareholders from revolting, and regulators have at least some clout.

In other words, the very things that should make the stock market a safer place for investors over the next few years may also make it a less rewarding one.