Where Are All the Prosecutions From the Crisis?

Peter J. Henning - September 27, 2010

A consistent question since the financial crisis in 2008 is why has the federal government not prosecuted any senior executives for their roles in the collapse of firms like Lehman Brothers and Bear Stearns or the risky investments that led to bailouts of onetime financial giants like the American International Group, Fannie Mae and Freddie Mac. How can companies worth billions of dollars just a few months earlier suddenly collapse in 2008 without someone being held responsible?

At a hearing before the Senate Judiciary Committee last week, Senator Ted Kaufman of Delaware summed up the frustration on Capitol Hill with the lack of any identifiable villains for the financial troubles of the last two years. “We have seen very little in the way of senior officer or boardroom-level prosecutions of the people on Wall Street who brought this country to the brink of financial ruin,” Mr. Kaufman said. “Why is that?”

Judge Ellen Segal Huvelle of the Federal District Court in Washington expressed similar frustration with the settlement between the Securities and Exchange Commission and Citigroup over the bank’s misstatements in 2007 regarding its exposure to subprime mortgage-backed securities. In its complaint, the S.E.C. refers repeatedly to “senior management” receiving information about increased losses in its portfolio from problems with subprime mortgages, but none were named in its complaint.

Although Judge Huvelle largely approved the settlement, she was confounded by the S.E.C.’s failure to at least identify which Citigroup executives were aware of the information. The judge said that “this is where the S.E.C. is doing a disservice to the public” by not providing any more details, or even charging executives for misleading shareholders.

Judge Huvelle also questioned the deterrent impact of the $75 million penalty the company will pay, or the similarly modest $100,000 and $80,000 penalties imposed in a separate administrative proceeding on two Citigroup officers for their roles in the company’s disclosures. She pointed out that “$75 million will not deter anyone from doing anything,” and that “a $100,000 fine is not a deterrent in corporate America to do a better job.”

At the Senate hearing in which Senator Kaufman questioned the dearth of prosecutions of senior executives, Robert Khuzami, director of enforcement at the S.E.C., testified that his agency has been much more aggressive in pursuing cases against Wall Street. He cited as one example the securities fraud charges filed against Goldman Sachs in April that the firm later settled for $550 million.

Like the Citigroup matter, however, the Goldman case did not name anyone in the firm’s senior management as a defendant, with only a lower-level trader, Fabrice Tourre, sued in the complaint. And in both cases the settlements involved an alleged violation of Section 17(a) of the Securities Act of 1933, which is the lowest-level fraud charge the S.E.C. can bring because it only entails negligence rather than intentional conduct.

The bankruptcy examiner’s report filed by Anton R. Valukas about Lehman Brothers that questioned the firm’s reporting of the so-called “Repo 105” transactions may provide the groundwork for civil fraud charges against former executives of the investment bank. As I discussed in a previous post, the likelihood of criminal charges arising from Lehman’s conduct in the months before its collapse in September 2008 is small, so an S.E.C. case is probably the most serious proceeding that may be pursued, if that ever occurs.

The S.E.C. has already accused executives at Countrywide Financial with civil fraud charges for making misleading statements about the company’s mortgage risks, and also accused its former chief executive, Angelo R. Mozilo, of insider trading for making approximately $140 million in profits by selling shares in the company in the months before its near collapse. The trial in that case is set to begin on Oct. 19.

Even in the Countrywide case, civil fraud charges simply do not resonate with the public in the same way as criminal charges, in large part because a term of imprisonment cannot be imposed in an S.E.C. action and the stigma is not nearly as great. The same would be true if the S.E.C. files suit against Lehman executives — it is “only” civil, not a criminal prosecution, so even just the catharsis of an unseemly perp walk will not be available.

One possible reason for the lack of prosecutions involving senior executives is the Supreme Court’s ruling in Skilling v. United States, involving Jeffrey K. Skilling, the former chief executive of Enron, that limits the right of honest services provision, 18 U.S.C. § 1346, for criminal fraud prosecutions to just those cases involving bribes and kickbacks. It is now impossible to pursue cases against corporate executives for questionable conduct that involved some measure of dishonesty that caused harm to the company unless it also resulted in the person lining his or her own pocket.

The Senate Judiciary Committee will hold a hearing on Tuesday entitled “Restoring Key Tools to Combat Fraud and Corruption After the Supreme Court’s Skilling Decision.” It will be interesting to see whether the absence of any high-profile criminal prosecutions from the financial crisis will be cited as a reason for Congress to amend the honest services law to reach corporate misconduct that does not involve some form of personal benefit to the defendant. In the Skilling case, the Supreme Court questioned whether a crime involving only a breach of fiduciary duty could pass muster.

Even if Congress were to amend the honest services statute to reach a broader range of corporate misconduct, it would not apply to anything that happened back in 2008. Mr. Kaufman’s question is likely to remain unanswered for quite a while because prosecutors have not shown much interest, at least to this point, in pursuing criminal cases against executives of companies involved in the financial crisis.