The Prosecution That Isn’t Happening

By James Kwak

People keep asking why no senior executive has gone to jail for the misdeeds that produced the financial crisis—and cost the United States more than $6 trillion, or $50,000 per household, in lost economic output. The usual answers are that no one did anything wrong (oh, come on) or, more realistically, that it’s too hard to convict individuals in complex financial fraud cases.

At the same time, however, the U.S. Attorney’s office for the Southern District of New York—the district that includes Wall Street—has amassed a 79-0 record in insider trading cases, including yesterday’s jury verdict against Mathew Martoma, a trader at the hedge fund firm SAC Capital Advisors. In Martoma’s case, he obtained confidential information about a clinical trial for a drug being manufactured by two pharmaceutical companies and, according to the jury, convinced his boss, Steven Cohen, to unload the firm’s positions in those two stocks.

Now, despite the 79-0 record (which includes guilty pleas), insider trading is not necessarily the easiest thing in the world to prove, especially in a criminal action. Insider trading is a violation of SEC Rule 10b-5 (see the Martoma indictment), which requires the prosecution to prove a series of elements, including scienter—that the defendant knew he was doing something wrong—beyond a reasonable doubt. Proving that something was going on inside someone’s head is tough, but it can be done.

Now guess what? Rule 10b-5 is also one of the ways to go after someone for the kind of securities fraud that helped produce the financial crisis. The SEC’s successful civil action against “Fabulous” Fabrice Tourre of Goldman Sachs, for defrauding investors in an ABACUS collateralized debt obligation, was also predicated on violations of Rule 10b-5 (and Section 17(a) of the Securities Act of 1933, which is similar). Yet while the Southern District has convicted 79 people of insider trading, when it comes to engineering the financial crisis, only two people have gone down—Tourre and Countrywide’s Rebecca Mairone—and they were both found liable on civil, not criminal charges. (And in Mairone’s case, the prosecution had to rely on special statutes covering fraud committed against government agencies.)

You might say that Mathew Martoma is no senior executive, and you would be right. As one witness said, Martoma was only a “grain of sand” next to Steven Cohen, the head of SAC Capital Advisors and the man the Southern District and the FBI really wanted to nail. But the SEC is going after Cohen, too, on civil charges of negligent supervision. That is, with eight SAC employees having been convicted of insider trading, the claim is that even if Cohen didn’t know what was going on (as of yet, the SEC seems to think they don’t have enough evidence to make that stick), he must have been negligent in supervising his firm’s portfolio managers.

So why isn’t anyone going after Lloyd Blankfein, Angelo Mozilo (for something other than dumping his own Countrywide stock), Jamie Dimon, or any of the other CEOs who, at best, were unaware that their lieutenants and foot soldiers were ripping off their clients? It’s true that negligent supervision is a specific type of liability that applies to investment advisors (although any big bank these days includes dozens of investment advisory firms within its umbrella), but it’s hard to imagine that an imaginative prosecutor couldn’t come up with another source of liability. Tourre, for example, was found liable for aiding and abetting wrongdoing committed by Goldman Sachs. Whom, then, was he aiding and abetting?

Sure, insider trading is a bad thing, but in the grand scheme of things it’s peanuts compared to the financial crisis and the behavior that produced it. The SEC likes to talk about maintaining “confidence in the markets” among ordinary investors, and people like Mathew Martoma certainly don’t help, but there are other, bigger things to worry about: the legal insider trading that corporate executives do routinely under cover of 10b5-1 plans, for one thing, or the prospect of a technological meltdown in the markets, for another.

It’s easy enough to come up with sinister theories for why the powers that be seem more interested in pursuing insider trading cases than financial crisis cases, which I won’t bother mentioning. There are less sinister theories as well. Maybe, five years after the financial crisis, it’s easier to tell a story about a rich hedge fund manager cheating (Martoma “bought the answer sheet,” U.S. Attorney Preet Bharara said) than about a less-rich investment banker misleading his even-less-rich buy-side clients investing their not-rich-at-all customers’ pension funds.

But that’s not the way the laws should be applied. Ideally, they should be applied fairly. We know that in a world of scarce resources it’s not possible to hold every wrongdoer accountable. Failing that, however, we should punish the people who do the most harm and deter the kinds of misbehavior that will cause the most harm in the future. It’s hard to think of something that caused more harm than the financial crisis. But the heavy artillery of our legal system are looking elsewhere.

32 thoughts on “The Prosecution That Isn’t Happening”

  1. Since it was academics, politicians–and their hangers on–and ‘community organizers’ who had the bright idea to change underwriting standards on home loans in the first place, without which there would have been no housing bubble in the first place, why not start prosecuting them?

  5. cause that wasnt the cause of the problem? the real reason that the mortgage crises happened was because wall street figured out how to make money on bad loans to those who werent covered by the that changes you mentioned? and those changes only really required reports to be done, from banks (not mortgage companies) to identify what they did for communities that they took deposits from . no in this case wall street was buying and selling the loans knowing that they were bad, but they sold them as AAA, to ‘investors’ (aka suckers).

  6. There is a concept called Deferred Prosecution Arrangements which protect executives from prosecution . The whole white collar crime process is different. One of the darlings of Wall Street Chris Christie helped develop the idea.

  7. Equally important, there is the insider dealings among former SEC and federal prosecutors cashing in by cutting deals on behalf of clients involving mild civil settlements. If you look past the over-hyped prose, Matt Tabbi gets to the bottom of the failures here:
    http://www.rollingstone.com/politics/news/why-isnt-wall-street-in-jail-20110216
    Nobody goes to jail. This is the mantra of the financial-crisis era, one that saw virtually every major bank and financial company on Wall Street embroiled in obscene criminal scandals that impoverished millions and collectively destroyed hundreds of billions, in fact, trillions of dollars of the world’s wealth — and nobody went to jail. Nobody, that is, except Bernie Madoff, a flamboyant and pathological celebrity con artist, whose victims happened to be other rich and famous people….

    The rest of them, all of them, got off. Not a single executive who ran the companies that cooked up and cashed in on the phony financial boom — an industrywide scam that involved the mass sale of mismarked, fraudulent mortgage-backed securities — has ever been convicted….

    Instead, federal regulators and prosecutors have let the banks and finance companies that tried to burn the world economy to the ground get off with carefully orchestrated settlements — whitewash jobs that involve the firms paying pathetically small fines without even being required to admit wrongdoing. To add insult to injury, the people who actually committed the crimes almost never pay the fines themselves; banks caught defrauding their shareholders often use shareholder money to foot the tab of justice. “If the allegations in these settlements are true,” says Jed Rakoff, a federal judge in the Southern District of New York, “it’s management buying its way off cheap, from the pockets of their victims.”

    To understand the significance of this, one has to think carefully about the efficacy of fines as a punishment for a defendant pool that includes the richest people on earth — people who simply get their companies to pay their fines for them. Conversely, one has to consider the powerful deterrent to further wrongdoing that the state is missing by not introducing this particular class of people to the experience of incarceration. “You put Lloyd Blankfein in pound-me-in-the-ass prison for one six-month term, and all this bullshit would stop, all over Wall Street,” says a former congressional aide. “That’s all it would take. Just once.”

    But that hasn’t happened. Because the entire system set up to monitor and regulate Wall Street is fucked up.

    Just ask the people who tried to do the right thing.

    Read more: http://www.rollingstone.com/politics/news/why-isnt-wall-street-in-jail-20110216#ixzz2siUD5DcY

  8. Yes, but that can be nollie prosequi, ( http://en.wikipedia.org/wiki/Nolle_prosequi ) which basicly means the court doesn’t quite have all the evidence needed to win a conviction and can later reopen the case, and in most cases with a greater charge than with the original case. Much as Christie is about to find out.

  9. It’s not obvious that fraud has been committed, or that it was central to the crisis. To put it another way, with all parties acting legally the system would also have generated the crisis. That seems like a political problem, not a criminal one.

    Arguably, fraud or negligence was committed by the rating agencies and others involved in risk classification. Also arguably, banks and/or fund managers misled or acted against their fiduciary duty to clients. These people probably ought to be prosecuted, and doing so would make the financial system, in its current form, healthier.

    But the crisis would have occurred anyway. The bubble was caused by banks issuing deposits for people to buy houses and holding those same houses as collateral, thus expanding both sides of their balance sheet. Perhaps the bubble got out of hand due to sloppy or fraudulent risk management, but the systemic problem is that bank money was allowed to inflate the value of its own collateral. That link has to be broken, by some means like full reserve banking, or radically different accounting standards, or a separation of bank powers. In any case the solution is to be found in systemic reform of the financial system, not a clean-up of its current structure.

    So I disagree. I think calling for prosecutions is unproductive and further deflects calls for significant restructuring.

  11. ———–quote———
    The American dream house – Fannie Mae gives minorities a chance
    The Washington Times – Friday, December 10, 1999
    Author: Franklin D. Raines

    A decade after the Berlin Wall collapsed, a wall of injustice still divides minority families from the American dream of owning a home. We must tear down this wall, and the free market is the greatest bulldozer.

    For instance, Fannie Mae brings private capital, management and efficiency to the task of expanding affordable homeownership in America. At the center of the housing finance system, Fannie Mae is a major force in the expansion of minority homeownership.

    Since Fannie Mae doesn’t make home loans ourselves, we back mortgage lenders by buying or securing loans they make in the primary market; the company does not serve minority borrowers directly. Nevertheless, Fannie Mae outperforms the overall market when it comes to financing minority lending, according to data provided to the U.S. Department of Housing and Urban Development (HUD), and Federal Reserve data gathered under the Home Mortgage Disclosure Act. Last year, Fannie Mae financed $46 billion in home loans for more than 450,000 minority families, 77 percent more than the previous year.

    By far, Fannie Mae is the largest single source of funds for minority homebuyers in the nation. Notably, Fannie Mae finances more minority homeowners than the federal government does through the FHA.

    In his column, “Minority housing gap: Fannie Mae, Freddie Mac fall short,” which ran Nov. 17, Martin Luther King III called for more progress in mortgage lending to minorities. We couldn’t agree more. Yet Mr. King suggests that Fannie Mae does less than the primary market when it comes to lending to minorities. Not so. Evidence to support this assertion, sourced to an Urban Institute study, was based on interviews with a handful of lenders, not solid loan data analysis. Another source, a U.S. General Accounting Office study, relied on outdated HUD data.

    In fact, when HUD Secretary Andrew Cuomo recently proposed to increase the percentage of the business Fannie Mae and Freddie Mac does with underserved families, as tough as the new targets are, Fannie Mae immediately signed up. This means we will devote 50 percent of our business to low- and moderate-income homebuyers.

    However, Fannie Mae’s commitment to underserved families goes well beyond the HUD mandate. Five years ago, Fannie Mae launched our Trillion Dollar Commitment, a pledge to invest $1 trillion to help 10 million underserved families become homeowners or obtain decent rental housing by 2001. We targeted lower-income families, residents of central cities and rural areas and others for whom mortgage finance has always been difficult to obtain. No company in the world has ever made such a commitment, but next year we will meet our goal ahead of schedule. Furthermore, over the 1990s Fannie Mae has carefully studied, surveyed and identified the specific barriers to minority homeownership, including income, credit, misinformation and even discrimination. Then we’ve systematically developed breakthrough strategies to dismantle the barriers. They include 3 percent down payment mortgages, technology that reduces closing costs and nearly $10 billion in experimental mortgages to challenge outdated assumptions about credit. Thirty-three percent of borrowers using our special community lending products were minority families.

    To reach families where they live, Fannie Mae has opened 44 local Partnership Offices across the nation and launched over $300 billion in local investment plans with lenders, city housing agencies, non-profit organizations and others. Fannie Mae also helps banks meet their Community Reinvestment Act requirements. Over past two years, we purchased over $3 billion in CRA loans; by 2002, we’ll buy $10 billion more. The Wall Street Journal “Business and Race” column described our impact on the housing finance industry this way: “Fannie Mae’s moves have rewritten the business plans of major lenders. To fight the information barrier, the Fannie Mae Foundation has pioneered consumer outreach to help families understand what it takes to buy a home and feel comfortable and confident with the process. An astounding 7.3 million consumers have responded, and 40 percent are minorities. Indeed, the Foundation’s new homebuyer education campaign, `Your Credit Matters,’ brought 24,000 responses fromminority families in the first 60 days.”

    These strategies have helped minority homeownership grow at a faster rate than that of white families, and minority homebuyers report they feel less discrimination. The racial divide still exists. Bridging it must be the first priority of the housing finance system. On this 50th anniversary of the National Housing Act, Fannie Mae is proud to lead the market to make the American dream of homeownership as diverse as the nation itself. Yet we will not be satisfied until the wall is down and the minority housing gap is closed.
    ———-endquote———

    Is Mr. Kwaak in favor of prosecuting Franklin Raines (who wrote the above in 1999)?

  12. If by sinister Mr Kwaak is referring to “Account Control Fraud”, something effectively prosecuted in the S&L crisis and En Ron, then things are worse than we think. William Black out of the Univ. of Missouri has made the issues perfectly clear. Mr. Kwaak is misinformed. The financial institutions are at the center of this disaster and their continued control, along with how cheaply republicans and democrats can be purchased insures continued disasters. Our republic and the democracy is drowning in a sea of money and irrelevant or uninformed commentary is not helpful.

  13. Is this a joke? The predatorclass fiends responsible for the grotesque crimes and abuses are tentacles of a giant predatorclass monster that also includes our socalled leaders, (corporate and political) our socalled justices, our socalled press, our socalled regulators, and defines our socalled system. 17 yearold minorities are prosecuted and sentenced to long jail terms for possession of small quantities of pot. These convictions brand them with a mark and stain that eliminates or radically reduces any possible option for gainful employment. Yet, then den of vipers and thieves in the predatorclass rotate through the private sector, into government or the socalled judicial system where they advance, protect, shield and work as advocates for predatorclass oligarchs and interests only to rotate back again into the private sector where they cash in on their previous advancement, protection, shielding, and advocacy machinations.

    There is no justice. There is no ruleoflaw, and there is no government of, by, and for the people. The socalled government is a toxic, putrid, unholy predatorclass beast advancing, shielding, protecting, and advocating predatorclass interests and oligarchs exclusively.

    In a world where there are no laws, there are no laws for anyone predatorclass biiiiaaaatches!

    Burn it all down! Reset!!! It’s the only hope for the people!!!!

  15. Blankfein, Mozilo just the tip of the iceberg.
    How about the BO admin for paying off the debt to balance the bank portfolios and hiring Geithner to fix the books inside the Fed Reserve after Paulson left.

    Leaving the 100,000,000+ Americans in the cold during and through the mess is felonious at best.

    Time for real and raw leadership to enter.the political arena, become President, create a fastrac path to correct the robbery of the American Public that took place between 2002-20014.

    I am speaking of Tax Credits for eac of the following:
    Credit card owners
    Home owners
    Biz owners
    Family court victims

    Our gov’t has been turning the other cheek on its own citizens and pointing the finger at unions as a major reason why inner cities and inflation bring the very same cities into bankruptcy.
    I speak clearly and loud in support for the unions as not being a reason for such…rather the financial downfall of America is clearly because banks & big oil/OPEC have never been kept in check by govt through policy that works for Americans….yet actually is backwards in that we have been working for them.

    Once again America, it is time to take back our own land and gov’t before another decade of financial slavery occurs.

    My name is George Brucato
    My twitter address is:
    @RunGeorgeRun
    I built BullUnion.com for the major Unions to ease the pressures associated with getting the unnorganized to organize rapidly and innexpensively.
    I will be deciding whether I will run for the highest office in the land to get on top of the above items and many more on or about Memorial Day weekend of this year-2014.

    Thank you again,
    George Brucato
    from

  16. Blankfein, Mozilo just the tip of the iceberg.
    How about the BO admin for paying off the debt to balance the bank portfolios and hiring Geithner to fix the books inside the Fed Reserve after Paulson left.

    Leaving the 100,000,000+ Americans in the cold during and through the mess is felonious at best.

    Time for real and raw leadership to enter.the political arena, become President, create a fastrac path to correct the robbery of the American Public that took place between 2002-20014.

    I am speaking of Tax Credits for eac of the following:
    Credit card owners
    Home owners
    Biz owners
    Family court victims

    Our gov’t has been turning the other cheek on its own citizens and pointing the finger at unions as a major reason why inner cities and inflation bring the very same cities into bankruptcy.
    I speak clearly and loud in support for the unions as not being a reason for such…rather the financial downfall of America is clearly because banks & big oil/OPEC have never been kept in check by govt through policy that works for Americans….yet actually is backwards in that we have been working for them.

    Once again America, it is time to take back our own land and gov’t before another decade of financial slavery occurs.

    My name is George Brucato
    My twitter address is:
    @RunGeorgeRun
    I built BullUnion.com for the major Unions to ease the pressures associated with getting the unnorganized to organize rapidly and innexpensively.
    I will be deciding whether I will run for the highest office in the land to get on top of the above items and many more on or about Memorial Day weekend of this year-2014.

    Thank you again,
    George Brucato
    from

  17. The ability to detect and punish cheaters was established as a necessary component of successful group-living, perhaps originally among bacteria, possibly billions of years ago. Though it’s of course far more difficult and challenging to detect and punish cheaters in a complex human society, our failure to do so more effectively underlies our inability to function as a successful group today.

  18. SEC have gone easy on CEOs of not having to admit legal wrong-doing because allowing admission of wrong-doing and liability would encourage numerous lawsuits that could bankrupt a company/ person(s) beyond the criminal/civil damage(s) defendant(s) was/were alleged to have committed. U.S. laws better protect the wealthy and well-connected, therefore, little or no jail time, period, end of story.

    “Most U.S. jurisdictions, Rakoff explained, require evidence of at least one crime by a manager to prosecute a company. If that can be proved, why not prosecute that person instead? Corporate executives, he said, love deferred prosecution agreements. Even if they require companies to pay hefty fines and adopt expensive reforms, they spare executives from investigation — and jail sentences. Going after companies is “technically and morally suspect,” Rakoff said.”

    “Calls by lawmakers, filmmakers and commentators to send bank executives to jail for causing the financial crisis are often slapped down by legal experts as populist diatribes from people who just don’t understand criminal law. The mortgage crisis, these experts say, was a society-wide breakdown involving home buyers, mortgage lenders, Wall Street securitizers, ratings companies and yield-seeking investors. But it wasn’t, at root, fraud.”

    “Judge Rakoff apparently disagrees. But even the outspoken jurist admits he is too late.”

  21. @George Brucato – it is MORE than fair to re-name the “crisis” and call it what it REALLY was – ECONOMIC GENOCIDE.

    Targeted, pre-meditated, and implemented by brute force GENOCIDE to pay for pre-meditated WARS.

    UNION for Ethical Scientists must be rapidly organized because the cheap labor replacements working in the food, medical, and public infrastructure industries (like WATER quality) are all doing things UNDER UNDUE DURESS (you get FIRED if you don’t mix the sick cow meat in with the other). Look at the daily list of stuff that has to be re-called!

    The prosecution is “crimes against humanity”, no matter how you look at it.

    There NEVER was a “Just War” discussion (see Wikipedia explanation of the history of “Just War” for my reference – and worse, anyone who took the discussion to that level were CENSORED – brutally – and targeted for economic genocide. The NSA ripping into FINANCIAL RECORDS is how it ALL became possible!

    http://www.huffingtonpost.com/kathleen-ann/american-used-to-haves_b_4732434.html

  24. The primary obstacle to the successful prosecution of white collar crime is the scienter requirement. Anyone who has ever gone through an expensive or messy divorce knows there is no bottom to the human capacity to rationalize abhorrent behavior, and to regard oneself as blameless. Our brains have a strong tendency to resist the conclusion that we are a bad person, or that we did something wrong, and instead exert impressive effort to justify our conduct by blaming the victim and explaining our boundless sense of entitlement. The criminogenic culture of Wall Street, and the sociopathic personality types it attracts, make this problem particularly severe. I strongly suspect that if you hooked Anthony Mozilla or Jamie Dimon up to an accurate lie detector and asked them if they had done anything wrong in acquiring their wealth, the machine would indicate they had truthfully answered “no.” Indeed, even Bernie Madoff seems to genuinely believe that his actions were somehow justified by the incompetence of the SEC and the greed and ignorance of his clients. The psychological reality of such financial rationalization means that, as a policy matter, we need to eliminate the scienter element from our white collar crime laws, and focus directly on the undesirable behavior we wish to prohibit. If it is illegal to give someone a mortgage they can’t afford to pay, as determined by a set mathematical formula and requisite set of income-verification documents, the person’s intent in doing so becomes as irrelevant as it should be.

  25. Issuing FIAT $$$$ as “debt” means a mortgage will never be paid off in the new world economy – that’s the DESIGN of the system.

    More misery for others = More $$$$ for ME ME ME

    Pre-emptive WAR will always pay off big with that math.

  26. They said it was going be a really big show tonight, I hope you can stick around to see the grand finale, I just don’t think the odds are in your favor.

  28. Indeed, insider Trading is a criminal offence and hence very difficult to prove because the standard of proof is much higher than a civil charge. I don’t understand why Preet Bharara didn’t (really) consider bringing criminal charges against Mr. Cohen using the conscious avoidance/disregard doctrine.

    Congrats on getting Freshly Pressed!

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