WASHINGTON — The Securities and Exchange Commission is paying $755,000 to settle a lawsuit with a former staff lawyer who accused the agency of blocking his investigation of a prominent hedge fund.
The SEC settlement of Gary Aguirre's wrongful termination claim resolved a long-running controversy that prompted scrutiny in Congress and by the SEC inspector general. The settlement was announced Tuesday by the Government Accountability Project.
Aguirre was fired by the SEC in September 2005. He went public in 2006 with allegations of interference by SEC officials in the probe of Pequot Capital Management and improper deference to a Wall Street executive whom Aguirre wanted to interview. That prompted an investigation by Republican staff of the Senate Judiciary and Finance Committees.
The SEC initially took no enforcement action in the case, which was started in 2004 and closed in 2006. The agency reopened it in January 2009 after documents emerged in a divorce proceeding showing that Pequot began paying $2.1 million to a key witness in the case in mid-2007.
Last month, Pequot and its founder and chairman, Arthur Samberg, agreed to pay a total of $28 million to settle the SEC's charges of insider trading of Microsoft Corp. shares. The SEC alleged that the hedge fund traded Microsoft shares on confidential information provided by a former employee of the technology giant whom it later hired.
Pequot, whose core hedge fund was liquidated last year, and Samberg, a well-known money manager and philanthropist, neither admitted nor denied wrongdoing.
The $755,000 being paid to Aguirre represents his salary for four years and 10 months plus his attorneys' fees, according to the Government Accountability Project, a group that works with whistleblowers. The group said it may be the largest settlement of its kind.
Under terms of the settlement, which was approved by a judge at the federal Merit Systems Protection Board, Aguirre agreed to drop two related cases against the SEC.
SEC spokesman John Nester said the settlement "resolves all outstanding litigation between the parties and reflects the agency's determination to focus on its core mission of protecting investors."
Aguirre, in a statement, said "I think it's fair to the public that the SEC pays for my work over the past four years and 10 months, since it generated $28 million to the U.S. Treasury. But it's a shame the team I worked with at the SEC did not get to complete the Pequot investigation. The filing of the case in 2005 or 2006, before the financial crisis, would have been exactly what the Wall Street elite needed to hear at the perfect moment: the SEC goes after big fish too."
In August 2007, the Republican staff of the two Senate committees published a scathing report criticizing the SEC's decision to fire Aguirre and close the first Pequot investigation. Sens. Charles Grassley, R-Iowa, and Arlen Specter of Pennsylvania, then a Republican, spoke critically on the Senate floor that year about the SEC's handling of the Pequot investigation.
The SEC inspector general, David Kotz, in a report issued in late 2008, found there were "serious questions" about the impartiality and fairness of the agency's probe of Pequot.
"The settlement with Mr. Aguirre shows that the SEC is finally acknowledging its mistake," Specter said in a statement Tuesday.
Is the SEC Covering Up Wall Street Crimes?
Matt Taibbi :
A whistle blower says the SEC agency has illegally
Imagine a world in which a man who is repeatedly investigated for a string of serious crimes, but never prosecuted, has his slate wiped clean every time the cops fail to make a case. No more Lifetime channel specials where the murderer is unveiled after police stumble upon past intrigues in some old file – "Hey, chief, didja know this guy had two wives die falling down the stairs?" No more burglary sprees cracked when some sharp cop sees the same name pop up in one too many witness statements. This is a different world, one far friendlier to lawbreakers, where even the suspicion of wrongdoing gets wiped from the record.
That, it now appears, is exactly how the Securities and Exchange Commission has been treating the Wall Street criminals who cratered the global economy a few years back. For the past two decades, according to a whistle-blower at the SEC who recently came forward to Congress, the agency has been systematically destroying records of its preliminary investigations once they are closed. By whitewashing the files of some of the nation's worst financial criminals, the SEC has kept an entire generation of federal investigators in the dark about past inquiries into insider trading, fraud and market manipulation against companies like Goldman Sachs, Deutsche Bank and AIG. With a few strokes of the keyboard, the evidence gathered during thousands of investigations – "18,000 ... including Madoff," as one high-ranking SEC official put it during a panicked meeting about the destruction – has apparently disappeared forever into the wormhole of history.
Under a deal the SEC worked out with the National Archives and Records Administration, all of the agency's records – "including case files relating to preliminary investigations" – are supposed to be maintained for at least 25 years. But the SEC, using history-altering practices that for once actually deserve the overused and usually hysterical term "Orwellian," devised an elaborate and possibly illegal system under which staffers were directed to dispose of the documents from any preliminary inquiry that did not receive approval from senior staff to become a full-blown, formal investigation. Amazingly, the wholesale destruction of the cases – known as MUIs, or "Matters Under Inquiry" – was not something done on the sly, in secret. The enforcement division of the SEC even spelled out the procedure in writing, on the commission's internal website. "After you have closed a MUI that has not become an investigation," the site advised staffers, "you should dispose of any documents obtained in connection with the MUI."
Many of the destroyed files involved companies and individuals who would later play prominent roles in the economic meltdown of 2008. Two MUIs involving con artist Bernie Madoff vanished. So did a 2002 inquiry into financial fraud at Lehman Brothers, as well as a 2005 case of insider trading at the same soon-to-be-bankrupt bank. A 2009 preliminary investigation of insider trading by Goldman Sachs was deleted, along with records for at least three cases involving the infamous hedge fund SAC Capital.
The widespread destruction of records was brought to the attention of Congress in July, when an SEC attorney named Darcy Flynn decided to blow the whistle. According to Flynn, who was responsible for helping to manage the commission's records, the SEC has been destroying records of preliminary investigations since at least 1993. After he alerted NARA to the problem, Flynn reports, senior staff at the SEC scrambled to hide the commission's improprieties.
As a federally protected whistle-blower, Flynn is not permitted to speak to the press. But in evidence he presented to the SEC's inspector general and three congressional committees earlier this summer, the 13-year veteran of the agency paints a startling picture of a federal police force that has effectively been conquered by the financial criminals it is charged with investigating. In at least one case, according to Flynn, investigators at the SEC found their desire to bring a case against an influential bank thwarted by senior officials in the enforcement division – whose director turned around and accepted a lucrative job from the very same bank they had been prevented from investigating. In another case, the agency farmed out its inquiry to a private law firm – one hired by the company under investigation. The outside firm, unsurprisingly, concluded that no further investigation of its client was necessary. To complete the bureaucratic laundering process, Flynn says, the SEC dropped the case and destroyed the files.
Much has been made in recent months of the government's glaring failure to police Wall Street; to date, federal and state prosecutors have yet to put a single senior Wall Street executive behind bars for any of the many well-documented crimes related to the financial crisis. Indeed, Flynn's accusations dovetail with a recent series of damaging critiques of the SEC made by reporters, watchdog groups and members of Congress, all of which seem to indicate that top federal regulators spend more time lunching, schmoozing and job-interviewing with Wall Street crooks than they do catching them. As one former SEC staffer describes it, the agency is now filled with so many Wall Street hotshots from oft-investigated banks that it has been "infected with the Goldman mindset from within."
The destruction of records by the SEC, as outlined by Flynn, is something far more than an administrative accident or bureaucratic fuck-up. It's a symptom of the agency's terminal brain damage. Somewhere along the line, those at the SEC responsible for policing America's banks fell and hit their head on a big pile of Wall Street's money – a blow from which the agency has never recovered. "From what I've seen, it looks as if the SEC might have sanctioned some level of case-related document destruction," says Sen. Chuck Grassley, the ranking Republican on the Senate Judiciary Committee, whose staff has interviewed Flynn. "It doesn't make sense that an agency responsible for investigations would want to get rid of potential evidence. If these charges are true, the agency needs to explain why it destroyed documents, how many documents it destroyed over what time frame and to what extent its actions were consistent with the law."
How did officials at the SEC wind up with a faithful veteran employee – a conservative, mid-level attorney described as a highly reluctant whistle-blower – spilling the agency's most sordid secrets to Congress? In a way, they asked for it.
On May 18th of this year, SEC enforcement director Robert Khuzami sent out a mass e-mail to the agency's staff with the subject line "Lawyers Behaving Badly." In it, Khuzami asked his subordinates to report any experiences they might have had where "the behavior of counsel representing clients in... investigations has been questionable."
Khuzami was asking staffers to recount any stories of outside counsel behaving unethically. But Flynn apparently thought his boss was looking for examples of lawyers "behaving badly" anywhere, including within the SEC. And he had a story to share he'd kept a lid on for years. "Mr. Khuzami may have gotten something more than he expected," Flynn's lawyer, a former SEC whistle-blower named Gary Aguirre, later explained to Congress.
Flynn responded to Khuzami with a letter laying out one such example of misbehaving lawyers within the SEC. It involved a case from very early in Flynn's career, back in 2000, when he was working with a group of investigators who thought they had a "slam-dunk" case against Deutsche Bank, the German financial giant. A few years earlier, Rolf Breuer, the bank's CEO, had given an interview to Der Spiegel in which he denied that Deutsche was involved in übernahmegespräche – takeover talks – to acquire a rival American firm, Bankers Trust. But the statement was apparently untrue – and it sent the stock of Bankers Trust tumbling, potentially lowering the price for the merger. Flynn and his fellow SEC investigators, suspecting that investors of Bankers Trust had been defrauded, opened a MUI on the case.
A Matter Under Inquiry is just a preliminary sort of look-see – a way for the SEC to check out the multitude of tips it gets about suspicious trades, shady stock scams and false disclosures, and to determine which of the accusations merit a formal investigation. At the MUI stage, an SEC investigator can conduct interviews or ask a bank to send in information voluntarily. Bumping a MUI up to a formal investigation is critical, because it enables investigators to pull out the full law-enforcement ass-kicking measures – subpoenas, depositions, everything short of hot pokers and waterboarding. In the Deutsche case, Flynn and other SEC investigators got past the MUI stage and used their powers to collect sworn testimony and documents indicating that plenty of übernahmegesprächeindeed had been going on when Breuer spoke to Der Spiegel. Based on the evidence, they sent an "Action Memorandum" to senior SEC staff, formally recommending that the agency press forward and file suit against Deutsche.
Breuer responded to the threat as big banks like Deutsche often do: He hired a former SEC enforcement director to lobby the agency to back off. The ex-insider, Gary Lynch, launched a creative and inspired defense, producing a linguistic expert who argued that übernahmegespräche only means "advanced stage of discussions." Nevertheless, the request to proceed with the case was approved by several levels of the SEC's staff. All that was needed to move forward was a thumbs-up from the director of enforcement at the time, Richard Walker.
But then a curious thing happened. On July 10th, 2001, Flynn and the other investigators were informed that Walker was mysteriously recusing himself from the Deutsche case. Two weeks later, on July 23rd, the enforcement division sent a letter to Deutsche that read, "Inquiry in the above-captioned matter has been terminated." The bank was in the clear; the SEC was dropping its fraud investigation. In contradiction to the agency's usual practice, it provided no explanation for its decision to close the case.
On October 1st of that year, the mystery was solved: Dick Walker was named general counsel of Deutsche. Less than 10 weeks after the SEC shut down its investigation of the bank, the agency's director of enforcement was handed a cushy, high-priced job at Deutsche.
Deutsche's influence in the case didn't stop there. A few years later, in 2004, Walker hired none other than Robert Khuzami, a young federal prosecutor, to join him at Deutsche. The two would remain at the bank until February 2009, when Khuzami joined the SEC as Flynn's new boss in the enforcement division. When Flynn sent his letter to Khuzami complaining about misbehavior by Walker, he was calling out Khuzami's own mentor.
The circular nature of the case illustrates the revolving-door dynamic that has become pervasive at the SEC. A recent study by the Project on Government Oversight found that over the past five years, former SEC personnel filed 789 notices disclosing their intent to represent outside companies before the agency – sometimes within days of their having left the SEC. More than half of the disclosures came from the agency's enforcement division, who went to bat for the financial industry four times more often than ex-staffers from other wings of the SEC.
Even a cursory glance at a list of the agency's most recent enforcement directors makes it clear that the SEC's top policemen almost always wind up jumping straight to jobs representing the banks they were supposed to regulate. Lynch, who represented Deutsche in the Flynn case, served as the agency's enforcement chief from 1985 to 1989, before moving to the firm of Davis Polk, which boasts many top Wall Street clients. He was succeeded by William McLucas, who left the SEC in 1998 to work for WilmerHale, a Wall Street defense firm so notorious for snatching up top agency veterans that it is sometimes referred to as "SEC West." McLucas was followed by Dick Walker, who defected to Deutsche in 2001, and he was in turn followed by Stephen Cutler, who now serves as general counsel for JP Morgan Chase. Next came Linda Chatman Thomsen, who stepped down to join Davis Polk, only to be succeeded in 2009 by Khuzami, Walker's former protégé at Deutsche Bank.
This merry-go-round of current and former enforcement directors has repeatedly led to accusations of improprieties. In 2008, in a case cited by the SEC inspector general, Thomsen went out of her way to pass along valuable information to Cutler, the former enforcement director who had gone to work for JP Morgan. According to the inspector general, Thomsen signaled Cutler that the SEC was unlikely to take action that would hamper JP Morgan's move to buy up Bear Stearns. In another case, the inspector general found, an assistant director of enforcement was instrumental in slowing down an investigation into the $7 billion Ponzi scheme allegedly run by Texas con artist R. Allen Stanford – and then left the SEC to work for Stanford, despite explicitly being denied permission to do so by the agency's ethics office. "Every lawyer in Texas and beyond is going to get rich on this case, OK?" the official later explained. "I hated being on the sidelines."
Small wonder, then, that SEC staffers often have trouble getting their bosses to approve full-blown investigations against even the most blatant financial criminals. For a fledgling MUI to become a formal investigation, it has to make the treacherous leap from the lower rungs of career-level staffers like Flynn all the way up to the revolving-door level at the top, where senior management is composed largely of high-priced appointees from the private sector who have strong social and professional ties to the very banks they are charged with regulating. And if senior management didn't approve an investigation, the documents often wound up being destroyed – as Flynn would later discover.
After the Deutsche fiasco over Bankers Trust, Flynn continued to work at the SEC for four more years. He briefly left the agency to dabble in real estate, then returned in 2008 to serve as an attorney in the enforcement division. In January 2010, he accepted new responsibilities that included helping to manage the disposition of records for the division – and it was then he first became aware of the agency's possibly unlawful destruction of MUI records.
Flynn discovered a directive on the enforcement division's internal website ordering staff to destroy "any records obtained in connection" with closed MUIs. The directive appeared to violate federal law, which gives responsibility for maintaining and destroying all records to the National Archives and Records Administration. Over a decade earlier, in fact, the SEC had struck a deal with NARA stipulating that investigative records were to be maintained for 25 years – and that if any files were to be destroyed after that, the shredding was to be done by NARA, not the SEC.
But Flynn soon learned that the records for thousands of preliminary investigations no longer existed. In his letter to Congress, Flynn estimates that the practice of destroying MUIs had begun as early as 1993, and has resulted in at least 9,000 case files being destroyed. For all the thousands of tips that had come in to the SEC, and the thousands of interviews that had been conducted by the agency's staff, all that remained were a few perfunctory lines for each case. The mountains of evidence gathered were no longer in existence.
To read through the list of dead and buried cases that Flynn submitted to Congress is like looking through an infrared camera at a haunted house of the financial crisis, with the ghosts of missed prosecutions flashing back and forth across the screen. A snippet of the list:
PARTY
MUI #
OPENED/CLOSED
ISSUE
Goldman Sachs
MLA-01909
6/99 - 4/00
Market Manipulation
Deutsche Bank
MHO-09356
11/01 - 7/02
Insider Trading
Deutsche Bank
MHO-09432
2/02 - 8/02
Market Manipulation
Lehman Brothers
MNY-07013
3/02 - 7/02
Financial Fraud
Goldman Sachs
MNY-08198
11/09 - 12/09
Insider Trading
One MUI – case MNY-08145 – involved allegations of insider trading at AIG on September 15th, 2008, right in the middle of the insurance giant's collapse. In that case, an AIG employee named Jacqueline Millan reported irregularities in the trading of AIG stock to her superiors, only to find herself fired. Incredibly, instead of looking into the matter itself, the SEC agreed to accept "an internal investigation by outside counsel or AIG." The last note in the file indicates that "the staff plans to speak with the outside attorneys on Monday, August 24th [2009], when they will share their findings with us." The fact that the SEC trusted AIG's lawyers to investigate the matter shows the basic bassackwardness of the agency's approach to these crash-era investigations. The SEC formally closed the case on October 1st, 2009.
The episode with AIG highlights yet another obstacle that MUIs experience on the road to becoming formal investigations. During the past decade, the SEC routinely began allowing financial firms to investigate themselves. Imagine the LAPD politely asking a gang of Crips and their lawyers to issue a report on whether or not a drive-by shooting by the Crips should be brought before a grand jury – that's basically how the SEC now handles many preliminary investigations against Wall Street targets.
The evolution toward this self-policing model began in 2001, when a shipping and food-service conglomerate called Seaboard aggressively investigated an isolated case of accounting fraud at one of its subsidiaries. Seaboard fired the guilty parties and made sweeping changes to its internal practices – and the SEC was so impressed that it instituted a new policy of giving "credit" to companies that police themselves. In practice, that means the agency simply steps aside and allows companies to slap themselves on the wrists. In the case against Seaboard, for instance, the SEC rewarded the firm by issuing no fines against it.
According to Lynn Turner, a former chief accountant at the SEC, the Seaboard case also prompted the SEC to begin permitting companies to hire their own counsel to conduct their own inquiries. At first, he says, the process worked fairly well. But then President Bush appointed the notoriously industry-friendly Christopher Cox to head up the SEC, and the "outside investigations" turned into whitewash jobs. "The investigations nowadays are probably not worth the money you spend on them," Turner says.
Harry Markopolos, a certified fraud examiner best known for sounding a famously unheeded warning about Bernie Madoff way back in 2000, says the SEC's practice of asking suspects to investigate themselves is absurd. In a serious investigation, he says, "the last person you want to trust is the person being accused or their lawyer." The practice helped Madoff escape for years. "The SEC took Bernie's word for everything," Markopolos says.
At the SEC, having realized that the agency was destroying documents, Flynn became concerned that he was overseeing an illegal policy. So in the summer of last year, he reached out to NARA, asking them for guidance on the issue.
That request sparked a worried response from Paul Wester, NARA's director of modern records. On July 29th, 2010, Wester sent a letter to Barry Walters, who oversees document requests for the SEC. "We recently learned from Darcy Flynn... that for the past 17 years the SEC has been destroying closed Matters Under Inquiry files," Wester wrote. "If you confirm that federal records have been destroyed improperly, please ensure that no further such disposals take place and provide us with a written report within 30 days."
Wester copied the letter to Adam Storch, a former Goldman Sachs executive who less than a year earlier had been appointed as managing executive of the SEC's enforcement division. Storch's appointment was not without controversy. "I'm not sure what's scarier," Daniel Indiviglio of The Atlantic observed, "that this guy worked at an investment bank that many believe has questionable ethics and too cozy a Washington connection, or that he's just 29." In any case, Storch reacted to the NARA letter the way the SEC often does – by circling the wagons and straining to find a way to blow off the problem without admitting anything.
Last August, as the clock wound down on NARA's 30-day deadline, Storch and two top SEC lawyers held a meeting with Flynn to discuss how to respond. Flynn's notes from the meeting, which he passed along to Congress, show the SEC staff wondering aloud if admitting the truth to NARA might be a bad idea, given the fact that there might be criminal liability.
"We could say that we do not believe there has been disposal inconsistent with the schedule," Flynn quotes Ken Hall, an assistant chief counsel for the SEC, as saying.
"There are implications to admit what was destroyed," Storch chimed in. It would be "not wise for me to take on the exposure voluntarily. If this leads to something, what rings in my ear is that Barry [Walters, the SEC documents officer] said: This is serious, could lead to criminal liability."
When the subject of how many files were destroyed came up, Storch answered: "18,000 MUIs destroyed, including Madoff."
Four days later, the SEC responded to NARA with a hilariously convoluted nondenial denial. "The Division is not aware of any specific instances of the destruction of records from any other MUI," the letter states. "But we cannot say with certainty that no such documents have been destroyed over the past 17 years." The letter goes on to add that "the Division has taken steps... to ensure that no MUI records are destroyed while we review this issue."
Translation: Hey, maybe records were destroyed, maybe they weren't. But if we did destroy records, we promise not to do it again – for now.
The SEC's unwillingness to admit the extent of the wrong doing left Flynn in a precarious position. The agency has a remarkably bad record when it comes to dealing with whistle-blowers. Back in 2005, when Flynn's attorney, Gary Aguirre, tried to pursue an insider-trading case against Pequot Capital that involved John Mack, the future CEO of Morgan Stanley, he was fired by phone while on vacation. Two Senate committees later determined that Aguirre, who has since opened a private practice representing whistle-blowers, was dismissed improperly as part of a "process of reprisal" by the SEC. Two whistle-blowers in the Stanford case, Julie Preuitt and Joel Sauer, also experienced retaliation – including reprimands and demotions – after raising concerns about superficial investigations. "There's no mechanism to raise these issues at the SEC," says another former whistle-blower. Contacting the agency's inspector general, he adds, is considered "the nuclear option" – a move "well-known to be a career-killer."
In Flynn's case, both he and Aguirre tried to keep the matter in-house, appealing to SEC chairman Mary Schapiro with a promise not to go outside the agency if she would grant Flynn protection against reprisal. When no such offer was forthcoming, Flynn went to the agency's inspector general before sending a detailed letter about the wrongdoing to three congressional committees.
One of the offices Flynn contacted was that of Sen. Grassley, who was in the midst of his own battle with the SEC. Frustrated with the agency's failure to punish major players on Wall Street, the Iowa Republican had begun an investigation into how the SEC follows up on outside complaints. Specifically, he wrote a letter to FINRA, another regulatory agency, to ask how many complaints it had referred to the SEC about SAC Capital, the hedge fund run by reptilian billionaire short-seller Stevie Cohen.
SAC has long been accused of a variety of improprieties, from insider trading to harassment. But no charge in recent Wall Street history is crazier than an episode involving a SAC executive named Ping Jiang, who was accused in 2006 of enacting a torturous hazing program. According to a civil lawsuit that was later dropped, Jiang allegedly forced a new trader named Andrew Tong to take female hormones, come to work wearing a dress and lipstick, have "foreign objects" inserted in his rectum, and allow Jiang to urinate in his mouth. (I'm not making this up.)
Grassley learned that over the past decade, FINRA had referred 19 complaints about suspicious trades at SAC to federal regulators. Curious to see how many of those referrals had been looked into, Grassley wrote the SEC on May 24th, asking for evidence that the agency had properly investigated the cases.
Two weeks later, on June 9th, Khuzami sent Grassley a surprisingly brusque answer: "We generally do not comment on the status of investigations or related referrals, and, in turn, are not providing information concerning the specific FINRA referrals you identified." Translation: We're not giving you the records, so blow us.
Grassley later found out from FINRA that it had actually referred 65 cases about SAC to the SEC, making the lack of serious investigations even more inexplicable. Angered by Khuzami's response, he sent the SEC another letter on June 15th demanding an explanation, but no answer has been forthcoming.
In the interim, Grassley's office was contacted by Flynn, who explained that among the missing MUIs he had uncovered were at least three involving SAC – one in 2006, one in 2007 and one in 2010, involving charges of insider trading and currency manipulation. All three cases were closed by the SEC, and the records apparently destroyed.
On August 17th, Grassley sent a letter to the SEC about the Flynn allegations, demanding to know if it was indeed true that the SEC had destroyed records. He also asked if the agency's failure to produce evidence of investigations into SAC Capital were related to the missing MUIs.
The SEC's inspector general is investigating the destroyed MUIs and plans to issue a report. NARA is also seeking answers. "We've asked the SEC to look into the matter and we're awaiting their response," says Laurence Brewer, a records officer for NARA. For its part, the SEC is trying to explain away the illegality of its actions through a semantic trick. John Nester, the agency's spokesman, acknowledges that "documents related to MUIs" have been destroyed. "I don't have any reason to believe that it hasn't always been the policy," he says. But Nester suggests that such documents do not "meet the federal definition of a record," and therefore don't have to be preserved under federal law.
But even if SEC officials manage to dodge criminal charges, it won't change what happened: The nation's top financial police destroyed more than a decade's worth of intelligence they had gathered on some of Wall Street's most egregious offenders. "The SEC not keeping the MUIs – you can see why this would be bad," says Markopolos, the fraud examiner famous for breaking the Madoff case. "The reason you would want to keep them is to build a pattern. That way, if you get five MUIs over a period of 20 years on something similar involving the same company, you should be able to connect five dots and say, 'You know, I've had five MUIs – they're probably doing something. Let's go tear the place apart.'" Destroy the MUIs, and Wall Street banks can commit the exact same crime over and over, without anyone ever knowing.
Regulation isn't a panacea. The SEC could have placed federal agents on every corner of lower Manhattan throughout the past decade, and it might not have put a dent in the massive wave of corruption and fraud that left the economy in flames three years ago. And even if SEC staffers from top to bottom had been fully committed to rooting out financial corruption, the agency would still have been seriously hampered by a lack of resources that often forces it to abandon promising cases due to a shortage of manpower. "It's always a triage," is how one SEC veteran puts it. "And it's worse now."
But we're equally in the dark about another hypothetical. Forget about what might have been if the SEC had followed up in earnest on all of those lost MUIs. What if even a handful of them had turned into real cases? How many investors might have been saved from crushing losses if Lehman Brothers had been forced to reveal its shady accounting way back in 2002? Might the need for taxpayer bailouts have been lessened had fraud cases against Citigroup and Bank of America been pursued in 2005 and 2007? And would the U.S. government have doubled down on its bailout of AIG if it had known that some of the firm's executives were suspected of insider trading in September 2008?
It goes without saying that no ordinary law-enforcement agency would willingly destroy its own evidence. In fact, when it comes to garden-variety crooks, more and more police agencies are catching criminals with the aid of large and well-maintained databases. "Street-level law enforcement is increasingly data-driven," says Bill Laufer, a criminology professor at the University of Pennsylvania. "For a host of reasons, though, we are starved for good data on both white-collar and corporate crime. So the idea that we would take the little data we do have and shred it, without a legal requirement to do so, calls for a very creative explanation."
We'll never know what the impact of those destroyed cases might have been; we'll never know if those cases were closed for good reasons or bad. We'll never know exactly who got away with what, because federal regulators have weighted down a huge sack of Wall Street's dirty laundry and dumped it in a lake, never to be seen again.
Editor’s Note: The online version of this article has been amended from the print version to reflect that the SEC’s case against Deutsche Bank proceeded beyond a Matter of Inquiry to a full-blown investigation.
SEC Revolving Door Fuels Wall Street's Too Big To Fail Problem
Posted: 02/11/2013 12:01 am EST | Updated: 02/11/2013 12:44 pm EST
Zach Carter
WASHINGTON -- The steady flow of officials from the Securities and Exchange Commission into top corporate jobs feeds a regulatory culture of weak law enforcement and preferential treatment for big banks, according to a new report from the Project on Government Oversight.
The group, a non-partisan investigative watchdog, said information it obtained through a Freedom of Information Act request shows 419 former SEC employees filed at least 1,949 disclosure statements revealing that they planned to represent a private-sector client with SEC business from 2001 to 2010. SEC employees are only required to file disclosure statements for the first two years after leaving the agency.
The flood of former SEC officials pressing the agency to go easy on their new private sector clients has influenced the outcome of dozens of cases in which the SEC issues official waivers exempting companies from standard penalties, the report said. These waivers appeared especially generous in cases involving repeat offenders -- companies that the SEC sanctions for multiple violations within a few years.
Big banks routinely receive this special treatment from the SEC, even after repeatedly breaking the law, the Project on Government Oversight said.
"Since 2003, the SEC had granted exemptions to JPMorgan and its subsidiaries when they were charged with alleged misconduct relating to mortgage securities products, transactions with Enron, initial product offerings, and research analyst conflicts of interest," the report said. JPMorgan Chase didn't reply to a request for comment.
Swiss banking giant UBS was granted waivers after the SEC charged the bank with violating the same anti-fraud provision of federal securities laws three different times from 2008 to 2012, according to the report. UBS declined to comment.
"The SEC has significant authority to crack down on companies that engage in wrongdoing, but too often the biggest Wall Street megabanks get a free pass in the form of penalty waivers and forbearance," Sen. Sherrod Brown (D-Ohio) told HuffPost. "It’s no wonder that the American public is so skeptical of the cozy relationship between Wall Street and Washington."
In recent years, the SEC granted 64 waivers that allowed companies to avoid new regulatory examinations. At least 35 were requested by former SEC employees, according to the report. Former SEC employees also secured 40 waivers that allowed offending companies to continue selling small amounts of stock without registering it. At least 16 former SEC officials helped their new private-sector employers continue to provide financial services that they would have been banned from supplying, the report said.
The SEC also at times simply exempts companies from some federal laws and provides so-called no-action letters informing firms they will not be pursued for legally ambiguous behavior.
"The revolving door is moving faster than ever," Sen. Chuck Grassley (R-Iowa) said. "This report documents exactly why it remains an ongoing concern. The SEC has to fix this problem once and for all. That involves more disclosure, more meaningful restrictions, and top-to-bottom application of the rules without waivers that make any restrictions meaningless."
Grassley emphasized the relevance of the revolving door with respect to Mary Jo White, President Barack Obama's nominee to succeed Mary Schapiro as Chairman of the SEC. White has a sterling record as an agressive prosecutor, but has also worked for top bankers involved in the financial crisis -- including former Bank of America CEO Ken Lewis -- as a defense attorney.
"It's especially important for the SEC to fix this problem with the arrival of a new chairman who, if confirmed, would bring a lot of good things to the commission but also a lot of connections to the securities industry she’d be regulating," Grassley said. "She’d need to operate under strict rules while at the commission and afterward if she returns to the private sector, and so should everyone else. Policing the revolving door is important to the integrity of rule-making and enforcement."
The Project on Government Oversight report shows that former SEC officials are often instrumental in securing special treatment for clients, with big banks some of the most fortunate. PNC, the ninth-largest American bank, with over $300 billion in assets, was the first company to receive a "no-action letter" based on new Dodd-Frank financial rules. As of February 2012, it was the only company to receive one. Although Dodd-Frank is aimed at reforming Wall Street, it includes new securities laws that apply to all companies -- not just financial firms. PNC declined to comment.
SEC spokesman John Nester said the the agency follows government regulations on conflicts. "We decide issues on their merits according to the rules and regulations governing the securities industry regardless of whether the requestors have an SEC background or not," he said. Nester added that the Government Accountability Office studied the SEC's revolving door, as it was required under Dodd-Frank, "and described the SEC’s controls as strong and consistent with those of other agencies."
In February 2012, the SEC responded to a New York Times story highlighting weak enforcement against big banks by saying that penalizing the firms for failures in specific divisions would hurt financial markets. The agency's explanation effectively acknowledged that the too-big-to-fail problem is ingrained in everyday enforcement.
"An SEC action against an investment bank -- for the conduct of one of its divisions -- could have the perverse effect of prohibiting that firm from managing mutual funds in a different division or subsidiary," three SEC officials wrote in a Feb. 3, 2011, New York Times letter to the editor. "Once abandoned by their advisers, these 'orphaned funds' could run the risk of serious losses, and customers could lose access to their money. It makes no sense for the commission to impose an unnecessary and artificial delay on a firm’s access to the capital markets for wholly unrelated conduct, especially if a delay would provide no benefit to investors and may harm the markets."
The barrage of advice and lobbying from ex-SEC staffers not only blunts enforcement efforts, it also appears to dilute or block new regulations, according to the report. In 2012, for example, SEC Chairman Mary Schapiro attempted to impose new rules on money market mutual funds, which had been lightly regulated. A frightening episode in the 2008 financial crisis was triggered when a large money market fund that had overinvested in Lehman Brothers was unable to make good on all of its obligations, sparking a massive run on other money market funds and threatening the entire financial system. The panic continued until the Federal Reserve stepped in to temporarily guarantee all money market investments.
The Project on Government Oversight report details how at least six former top SEC officials pressed the agency to drop new plans to regulate money market funds. They included a former top SEC lawyer, a former head of the Division of Investment Management, and Laura Unger, a former commissioner and acting chairman. The former SEC staff members wrote letters, met with SEC commissioners and even personally urged Schapiro to drop the effort, according to the report.
Schapiro ultimately abandoned the attempt to regulate money funds after Luis Aguilar, an SEC commissioner who usually favors strong regulations, indicated he would not support the new rules. Before joining the SEC, Aguilar worked for mutual funds.
The Financial Crisis:
Why Have No High Level Executives Been Prosecuted?
Five years have passed since the onset of what is sometimes called the Great Recession. While the economy has slowly improved, there are still millions of Americans leading lives of quiet desperation: without jobs, without resources, without hope.
Who was to blame? Was it simply a result of negligence, of the kind of inordinate risk-taking commonly called a “bubble,” of an imprudent but innocent failure to maintain adequate reserves for a rainy day? Or was it the result, at least in part, of fraudulent practices, of dubious mortgages portrayed as sound risks and packaged into ever more esoteric financial instruments, the fundamental weaknesses of which were intentionally obscured?
If it was the former—if the recession was due, at worst, to a lack of caution—then the criminal law has no role to play in the aftermath. For in all but a few circumstances (not here relevant), the fierce and fiery weapon called criminal prosecution is directed at intentional misconduct, and nothing less. If the Great Recession was in no part the handiwork of intentionally fraudulent practices by high-level executives, then to prosecute such executives criminally would be “scapegoating” of the most shallow and despicable kind.
But if, by contrast, the Great Recession was in material part the product of intentional fraud, the failure to prosecute those responsible must be judged one of the more egregious failures of the criminal justice system in many years. Indeed, it would stand in striking contrast to the increased success that federal prosecutors have had over the past fifty years or so in bringing to justice even the highest-level figures who orchestrated mammoth frauds. Thus, in the 1970s, in the aftermath of the “junk bond” bubble that, in many ways, was a precursor of the more recent bubble in mortgage-backed securities, the progenitors of the fraud were all successfully prosecuted, right up to Michael Milken.
Again, in the 1980s, the so-called savings-and-loan crisis, which again had some eerie parallels to more recent events, resulted in the successful criminal prosecution of more than eight hundred individuals, right up to Charles Keating. And again, the widespread accounting frauds of the 1990s, most vividly represented by Enron and WorldCom, led directly to the successful prosecution of such previously respected CEOs as Jeffrey Skilling and Bernie Ebbers.
In striking contrast with these past prosecutions, not a single high-level executive has been successfully prosecuted in connection with the recent financial crisis, and given the fact that most of the relevant criminal provisions are governed by a five-year statute of limitations, it appears likely that none will be. It may not be too soon, therefore, to ask why.
One possibility, already mentioned, is that no fraud was committed. This possibility should not be discounted. Every case is different, and I, for one, have no opinion about whether criminal fraud was committed in any given instance.
But the stated opinion of those government entities asked to examine the financial crisis overall is not that no fraud was committed. Quite the contrary. For example, the Financial Crisis Inquiry Commission, in its final report, uses variants of the word “fraud” no fewer than 157 times in describing what led to the crisis, concluding that there was a “systemic breakdown,” not just in accountability, but also in ethical behavior.
As the commission found, the signs of fraud were everywhere to be seen, with the number of reports of suspected mortgage fraud rising twenty-fold between 1996 and 2005 and then doubling again in the next four years. As early as 2004, FBI Assistant Director Chris Swecker was publicly warning of the “pervasive problem” of mortgage fraud, driven by the voracious demand for mortgage-backed securities. Similar warnings, many from within the financial community, were disregarded, not because they were viewed as inaccurate, but because, as one high-level banker put it, “A decision was made that ‘We’re going to have to hold our nose and start buying the stated product if we want to stay in business.’”
Without giving further examples, the point is that, in the aftermath of the financial crisis, the prevailing view of many government officials (as well as others) was that the crisis was in material respects the product of intentional fraud. In a nutshell, the fraud, they argued, was a simple one. Subprime mortgages, i.e., mortgages of dubious creditworthiness, increasingly provided the chief collateral for highly leveraged securities that were marketed as AAA, i.e., securities of very low risk. How could this transformation of a sow’s ear into a silk purse be accomplished unless someone dissembled along the way?
While officials of the Department of Justice have been more circumspect in describing the roots of the financial crisis than have the various commissions of inquiry and other government agencies, I have seen nothing to indicate their disagreement with the widespread conclusion that fraud at every level permeated the bubble in mortgage-backed securities. Rather, their position has been to excuse their failure to prosecute high-level individuals for fraud in connection with the financial crisis on one or more of three grounds:
First, they have argued that proving fraudulent intent on the part of the high-level management of the banks and companies involved has been difficult. It is undoubtedly true that the ranks of top management were several levels removed from those who were putting together the collateralized debt obligations and other securities offerings that were based on dubious mortgages; and the people generating the mortgages themselves were often at other companies and thus even further removed. And I want to stress again that I have no opinion whether any given top executive had knowledge of the dubious nature of the underlying mortgages, let alone fraudulent intent.
But what I do find surprising is that the Department of Justice should view the proving of intent as so difficult in this case. Who, for example, was generating the so-called “suspicious activity reports” of mortgage fraud that, as mentioned, increased so hugely in the years leading up to the crisis? Why, the banks themselves. A top-level banker, one might argue, confronted with growing evidence from his own and other banks that mortgage fraud was increasing, might have inquired why his bank’s mortgage-based securities continued to receive AAA ratings. And if, despite these and other reports of suspicious activity, the executive failed to make such inquiries, might it be because he did not want to know what such inquiries would reveal?
This, of course, is what is known in the law as “willful blindness” or “conscious disregard.” It is a well-established basis on which federal prosecutors have asked juries to infer intent, including in cases involving complexities, such as accounting rules, at least as esoteric as those involved in the events leading up to the financial crisis. And while some federal courts have occasionally expressed qualifications about the use of the willful blindness approach to prove intent, the Supreme Court has consistently approved it. As that Court stated most recently in Global-Tech Appliances, Inc. v. SEB S.A. (2011):
The doctrine of willful blindness is well established in criminal law. Many criminal statutes require proof that a defendant acted knowingly or willfully, and courts applying the doctrine of willful blindness hold that defendants cannot escape the reach of these statutes by deliberately shielding themselves from clear evidence of critical facts that are strongly suggested by the circumstances.
Thus, the department’s claim that proving intent in the financial crisis is particularly difficult may strike some as doubtful.
Second, and even weaker, the Department of Justice has sometimes argued that, because the institutions to whom mortgage-backed securities were sold were themselves sophisticated investors, it might be difficult to prove reliance. Thus, in defending the failure to prosecute high-level executives for frauds arising from the sale of mortgage-backed securities, Lanny Breuer, the then head of the Department of Justice’s Criminal Division, told PBS:
In a criminal case…I have to prove not only that you made a false statement but that you intended to commit a crime, and also that the other side of the transaction relied on what you were saying. And frankly, in many of the securitizations and the kinds of transactions we’re talking about, in reality you had very sophisticated counterparties on both sides. And so even though one side may have said something was dark blue when really we can say it was sky blue, the other side of the transaction, the other sophisticated party, wasn’t relying at all on the description of the color.
Actually, given the fact that these securities were bought and sold at lightning speed, it is by no means obvious that even a sophisticated counterparty would have detected the problems with the arcane, convoluted mortgage-backed derivatives they were being asked to purchase. But there is a more fundamental problem with the above-quoted statement from the former head of the Criminal Division, which is that it totally misstates the law. In actuality, in a criminal fraud case the government is never required to prove—ever—that one party to a transaction relied on the word of another. The reason, of course, is that that would give a crooked seller a license to lie whenever he was dealing with a sophisticated buyer. The law, however, says that society is harmed when a seller purposely lies about a material fact, even if the immediate purchaser does not rely on that particular fact, because such misrepresentations create problems for the market as a whole. And surely there never was a situation in which the sale of dubious mortgage-backed securities created more of a problem for the marketplace, and society as a whole, than in the recent financial crisis.
The third reason the department has sometimes given for not bringing these prosecutions is that to do so would itself harm the economy. Thus, Attorney General Eric Holder himself told Congress:
It does become difficult for us to prosecute them when we are hit with indications that if you do prosecute—if you do bring a criminal charge—it will have a negative impact on the national economy, perhaps even the world economy.
To a federal judge, who takes an oath to apply the law equally to rich and to poor, this excuse—sometimes labeled the “too big to jail” excuse—is disturbing, frankly, in what it says about the department’s apparent disregard for equality under the law.
In fairness, however, Holder (who later claimed his comment was misconstrued) was referring to the prosecution of financial institutions, rather than their CEOs. Moreover, he might have also been influenced, as his department unquestionably was, by the adverse reaction to the Arthur Anderson case, where that accounting firm was forced out of business by a prosecution that was ultimately reversed on appeal. But if we are talking about prosecuting individuals, the excuse becomes entirely irrelevant; for no one that I know of has ever contended that a big financial institution would collapse if one or more of its high-level executives were prosecuted, as opposed to the institution itself.
Eric Holder; drawing by John Springs
Without multiplying examples further, my point is that the Department of Justice has never taken the position that all the top executives involved in the events leading up to the financial crisis were innocent; rather it has offered one or another excuse for not criminally prosecuting them—excuses that, on inspection, appear unconvincing. So, you might ask, what’s really going on here? I don’t claim to have any inside information about the real reasons why no such prosecutions have been brought, but I take the liberty of offering some speculations.
At the outset, however, let me say that I completely discount the argument sometimes made that no such prosecutions have been brought because the top prosecutors were often people who previously represented the financial institutions in question and/or were people who expected to be representing such institutions in the future: the so-called “revolving door.” In my experience, most federal prosecutors, at every level, are seeking to make a name for themselves, and the best way to do that is by prosecuting some high-level person. While companies that are indicted almost always settle, individual defendants whose careers are at stake will often go to trial. And if the government wins such a trial, as it usually does, the prosecutor’s reputation is made. My point is that whatever small influence the “revolving door” may have in discouraging certain white-collar prosecutions is more than offset, at least in the case of prosecuting high-level individuals, by the career-making benefits such prosecutions confer on the successful prosecutor.
So, one asks again, why haven’t we seen such prosecutions growing out of the financial crisis? I offer, by way of speculation, three influences that I think, along with others, have had the effect of limiting such prosecutions.
First, the prosecutors had other priorities. Some of these were completely understandable. For example, before 2001, the FBI had more than one thousand agents assigned to investigating financial frauds, but after September 11 many of these agents were shifted to antiterrorism work. Who can argue with that? Yet the result was that, by 2007 or so, there were only 120 agents reviewing the more than 50,000 reports of mortgage fraud filed by the banks. It is true that after the collapse of Lehman Brothers in 2008, new agents were hired for some of the vacated spots in offices concerned with fraud detection; but this is not a form of detection easily learned, and recent budget limitations have only exacerbated the problem.
Of course, while the FBI has substantial responsibility for investigating mortgage fraud, the FBI is not the primary investigator of fraud in the sale of mortgage-backed securities; that responsibility lies mostly with the SEC. But at the very time the financial crisis was breaking, the SEC was trying to deflect criticism from its failure to detect the Madoff fraud, and this led it to concentrate on other Ponzi-like schemes that emerged in the wake of the financial crisis, along with cases involving misallocation of assets (such as stealing funds from a customer), which are among the easiest cases to prove. Indeed, as Professor John Coffee of Columbia Law School has repeatedly documented, Ponzi schemes and misallocation-of-asset cases have been the primary focus of the SEC since 2009, while cases involving fraud in the sale of mortgage-backed securities have been much less frequent. More recently, moreover, the SEC has been hard hit by budget limitations, and this has not only made it more difficult to assign the kind of manpower the kinds of frauds we are talking about require, but also has led the SEC enforcement staff to focus on the smaller, easily resolved cases that will beef up their statistics when they go to Congress begging for money.
As for the Department of Justice proper, a decision was made in 2009 to spread the investigation of financial fraud cases among numerous US Attorney’s Offices, many of which had little or no previous experience in investigating and prosecuting sophisticated financial frauds. This was in connection with the president’s creation of a special task force to investigate the crisis, from which remarkably little has been heard in the intervening four-plus years. At the same time, the US Attorney’s Office with the greatest expertise in these kinds of cases, the Southern District of New York, was just embarking on its prosecution of insider-trading cases arising from the Raj Rajaratnam tapes, which soon proved a gold mine of prosecutable cases that absorbed a huge amount of the attention of the securities fraud unit of that office.
While I want to stress again that I have no inside information, as a former chief of that unit I would venture to guess that the cases involving the financial crisis were parceled out to assistant US attorneys who were also responsible for insider-trading cases. Which do you think an assistant would devote most of her attention to: an insider-trading case that was already nearly ready to go to indictment and that might lead to a high-visibility trial, or a financial crisis case that was just getting started, would take years to complete, and had no guarantee of even leading to an indictment? Of course, she would put her energy into the insider-trading case, and if she was lucky, it would go to trial, she would win, and, in some cases, she would then take a job with a large law firm. And in the process, the financial fraud case would get lost in the shuffle.
In short, a focus on quite different priorities is, I submit, one of the reasons the financial fraud cases have not been brought, especially cases against high-level individuals that would take many years, many investigators, and a great deal of expertise to investigate. But a second, and less salutary, reason for not bringing such cases is the government’s own involvement in the underlying circumstances that led to the financial crisis.
On the one hand, the government, writ large, had a part in creating the conditions that encouraged the approval of dubious mortgages. Even before the start of the housing boom, it was the government, in the form of Congress, that repealed the Glass-Steagall Act, thus allowing certain banks that had previously viewed mortgages as a source of interest income to become instead deeply involved in securitizing pools of mortgages in order to obtain the much greater profits available from trading. It was the government, in the form of both the executive and the legislature, that encouraged deregulation, thus weakening the power and oversight not only of the SEC but also of such diverse banking overseers as the Office of Thrift Supervision and the Office of the Comptroller of the Currency, both in the Treasury Department. It was the government, in the form of the Federal Reserve, that kept interest rates low, in part to encourage mortgages. It was the government, in the form of the executive, that strongly encouraged banks to make loans to individuals with low incomes who might have previously been regarded as too risky to warrant a mortgage.
Thus, in the year 2000, HUD Secretary Andrew Cuomo increased to 50 percent the percentage of low-income mortgages that the government-sponsored entities known as Fannie Mae and Freddie Mac were required to purchase, helping to create the conditions that resulted in over half of all mortgages being subprime at the time the housing market began to collapse in 2007.
It was the government, pretty much across the board, that acquiesced in the ever-greater tendency not to require meaningful documentation as a condition of obtaining a mortgage, often preempting in this regard state regulations designed to assure greater mortgage quality and a borrower’s ability to repay. Indeed, in the year 2000, the Office of Thrift Supervision, having just finished a successful campaign to preempt state regulation of thrift underwriting, terminated its own underwriting regulations entirely.
The result of all this was the mortgages that later became known as “liars’ loans.” They were increasingly risky; but what did the banks care, since they were making their money from the securitizations. And what did the government care, since it was helping to create a boom in the economy and helping voters to realize their dream of owning a home?
Moreover, the government was also deeply enmeshed in the aftermath of the financial crisis. It was the government that proposed the shotgun marriages of, among others, Bank of America with Merrill Lynch, and of J.P. Morgan with Bear Stearns. If, in the process, mistakes were made and liabilities not disclosed, was it not partly the government’s fault? One does not necessarily have to adopt the view of Neil Barofsky, former special inspector general in charge of oversight of TARP, that regulators made almost no effort to hold accountable the financial institutions they were bailing out, to wonder whether the government, having helped create the conditions that led to the seeming widespread fraud in the mortgage-backed securities market, was all too ready to forgive its alleged perpetrators.
Please do not misunderstand me. I am not suggesting that the government knowingly participated in any of the fraudulent practices alleged by the Financial Inquiry Crisis Commission and others. But what I am suggesting is that the government was deeply involved, from beginning to end, in helping create the conditions that could lead to such fraud, and that this would give a prudent prosecutor pause in deciding whether to indict aCEO who might, with some justice, claim that he was only doing what he fairly believed the government wanted him to do.
The final factor I would mention is both the most subtle and the most systemic of the three, and arguably the most important. It is the shift that has occurred, over the past thirty years or more, from focusing on prosecuting high-level individuals to focusing on prosecuting companies and other institutions. It is true that prosecutors have brought criminal charges against companies for well over a hundred years, but until relatively recently, such prosecutions were the exception, and prosecutions of companies without simultaneous prosecutions of their managerial agents were even rarer.
The reasons were obvious. Companies do not commit crimes; only their agents do. And while a company might get the benefit of some such crimes, prosecuting the company would inevitably punish, directly or indirectly, the many employees and shareholders who were totally innocent. Moreover, under the law of most US jurisdictions, a company cannot be criminally liable unless at least one managerial agent has committed the crime in question; so why not prosecute the agent who actually committed the crime?
In recent decades, however, prosecutors have been increasingly attracted to prosecuting companies, often even without indicting a single person. This shift has often been rationalized as part of an attempt to transform “corporate cultures,” so as to prevent future such crimes; and as a result, government policy has taken the form of “deferred prosecution agreements” or even “nonprosecution agreements,” in which the company, under threat of criminal prosecution, agrees to take various prophylactic measures to prevent future wrongdoing. Such agreements have become, in the words of Lanny Breuer, the former head of the Department of Justice’s Criminal Division, “a mainstay of white-collar criminal law enforcement,” with the department entering into 233 such agreements over the last decade. But in practice, I suggest, this approach has led to some lax and dubious behavior on the part of prosecutors, with deleterious results.
If you are a prosecutor attempting to discover the individuals responsible for an apparent financial fraud, you go about your business in much the same way you go after mobsters or drug kingpins: you start at the bottom and, over many months or years, slowly work your way up. Specifically, you start by “flipping” some lower- or mid-level participant in the fraud who you can show was directly responsible for making one or more false material misrepresentations but who is willing to cooperate, and maybe even “wear a wire”—i.e., secretly record his colleagues—in order to reduce his sentence. With his help, and aided by the substantial prison penalties now available in white-collar cases, you go up the ladder.
But if your priority is prosecuting the company, a different scenario takes place. Early in the investigation, you invite in counsel to the company and explain to him or her why you suspect fraud. He or she responds by assuring you that the company wants to cooperate and do the right thing, and to that end the company has hired a former assistant US attorney, now a partner at a respected law firm, to do an internal investigation. The company’s counsel asks you to defer your investigation until the company’s own internal investigation is completed, on the condition that the company will share its results with you. In order to save time and resources, you agree.
Six months later the company’s counsel returns, with a detailed report showing that mistakes were made but that the company is now intent on correcting them. You and the company then agree that the company will enter into a deferred prosecution agreement that couples some immediate fines with the imposition of expensive but internal prophylactic measures. For all practical purposes the case is now over. You are happy because you believe that you have helped prevent future crimes; the company is happy because it has avoided a devastating indictment; and perhaps the happiest of all are the executives, or former executives, who actually committed the underlying misconduct, for they are left untouched.
I suggest that this is not the best way to proceed. Although it is supposedly justified because it prevents future crimes, I suggest that the future deterrent value of successfully prosecuting individuals far outweighs the prophylactic benefits of imposing internal compliance measures that are often little more than window-dressing. Just going after the company is also both technically and morally suspect. It is technically suspect because, under the law, you should not indict or threaten to indict a company unless you can prove beyond a reasonable doubt that some managerial agent of the company committed the alleged crime; and if you can prove that, why not indict the manager? And from a moral standpoint, punishing a company and its many innocent employees and shareholders for the crimes committed by some unprosecuted individuals seems contrary to elementary notions of moral responsibility.
These criticisms take on special relevance, however, in the instance of investigations growing out of the financial crisis, because, as noted, the Department of Justice’s position, until at least recently, is that going after the suspect institutions poses too great a risk to the nation’s economic recovery. So you don’t go after the companies, at least not criminally, because they are too big to jail; and you don’t go after the individuals, because that would involve the kind of years-long investigations that you no longer have the experience or the resources to pursue.
In conclusion, I want to stress again that I do not claim that the financial crisis that is still causing so many of us so much pain and despondency was the product, in whole or in part, of fraudulent misconduct. But if it was—as various governmental authorities have asserted it was—then the failure of the government to bring to justice those responsible for such colossal fraud bespeaks weaknesses in our prosecutorial system that need to be addressed.
Jed S. Rakoff (born August 1, 1943) is a United States District Judge on senior status for the Southern District of New York.
