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Source: Investment U

Posted on September 7, 2011

Last week, Google agreed to pay nine figures for illegally showing ads of online pharmacies that operate outside of U.S. jurisdiction. Some of the pharmacies were selling counterfeit drugs from outside North America. Others were fake entities set up by the government to find cracks in Google's ad systems. And cracks, they found...

Still, what's a $500 million fine when your market cap sits north of $167 billion? That's what Google executives might think when they cut a check to the government this week.

And it won't be the first time they've forked big money over to regulators, either. The ad giant has paid millions to U.S. and European regulators over the past decade for a variety of infractions. And just this year, the company paid fines for patent infringement and breaches of privacy.

This all begs a larger question: Will enormous fines deter corporations like Google from engaging in risky behavior?

Even before this fine, I began thinking that Google was fast becoming the Goldman Sachs of the tech world. Both companies have strong ties to the regulatory bodies in charge of monitoring them. Goldman has a revolving door leading to the U.S. Treasury. And Google is so close to the FCC that agency head Julius Genachowski is wearing the company's varsity jacket. (For example, Google heavily influenced the FCC's push for "net neutrality" which bars Internet providers such as AT&T from controlling Google search traffic.)

Also, both companies appeared to have built fines into their business model.

During the 1990s Dotcom Bubble, Goldman faced a series of complaints about "laddering" their scheme that let big-money players in early on IPOs. Then there's the more recent $550-million settlement with the SEC over a fraud case involving dicey mortgage derivatives. After Goldman made billions of dollars in profits, the company paid what's little more than a traffic ticket in the end. Oh... yeah... and Goldman promised to "conduct a sweeping review of business standards."

If the market environment encourages a firm to take a speeding ticket now and then, why not sell a risky product, lawyer up, collect bundles of cash, and then play dumb when they're caught? A slap on the wrist and a change in bureaucrats later, and they can find a new market to exploit...

But this pharmaceutical investigation and fine appears different on the surface. The $500-million fine represents more than 20 percent of Google's net profits from the first quarter of this year. It also signals that the U.S. government and the Food and Drug Administration (FDA) aren't waiting around to find out what happens when a group of customers end up purchasing counterfeit Xanax or Viagra.

Now, there are many valid arguments on why cross-border drug restrictions should or should not exist. But this event is an entirely different animal...

Google banned the drug ads for these companies in 2003, but lifted the ban a year later, despite repeated warnings from the FDA. Then Google went a step further by providing advice to these foreign companies on how to optimize their search terms and improve their websites' ad programs. Not only had Google drawn considerable attention to themselves by lifting the ban (when Yahoo! and Microsoft didn't), but they also encouraged the illegal advertising of these products despite the FDA's repeated warnings.

And the government finally said enough was enough. For years, there was a lack of transparency in a number of corporate practices (and government, too). From Wall Street to Main Street, we're still discovering things from the financial crisis that we probably didn't want to know. Goldman Sachs is now facing a serious investigation, one that personally threatens the CEO.

In the Gulf of Mexico, Exxon's engaged in a fight with the government after their leases for a massive oil field expired in 2008. If they poke too hard, it could open up discussions about some of their practices should the battle go to court...

And right now, the S&P is under investigation over its faulty ratings practices during the housing bubble. Of course, this investigation has nothing to do with the $1-trillion loss U.S. stockholders faced after the company's recent downgrade of American debt.

So if you're an investor in a company subject to heavy regulation or potential fines, it's important to pay attention to the legal developments. It could be a very long year in corporate America if the current administration begins to dig deeper, particularly if someone's looking for a bad guy with the election approaching.

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