You won't find a better, more incisive
discussion of the question than the
one by U.S. District Judge Jed Rakoff of New York in
current issue of the New York Review of Books.
Rakoff, 70, is the right person to raise the
issue. He's a former federal prosecutor in Manhattan, where he handled
business and securities fraud. A Clinton appointee, he's been on the
bench for more than 17 years.
It's unsurprising to find Rakoff emerging as
a critic of the government's hands-off treatment of Wall Street and
banking big shots in the aftermath of
the financial crisis:
shown much patience for the settlements in which the Department of
Justice and the
Securities and Exchange Commission allow corporations and executives
to wriggle out of cases by paying nominal penalties and promising not to
be bad in the future.
These are known as "consent decrees."
In 2009, he tossed a $33-million
settlement of a white-collar case with
Bank of America, calling it,
"a contrivance designed to provide the
S.E.C. with the facade of enforcement and the management of the Bank
with a quick resolution of an embarrassing inquiry."
The parties later agreed to a higher fine
and stricter terms. And in 2011 he rejected a $285-million consent
Citigroup entered with the SEC. That rejection is still being
pondered by a federal appeals court.
In his new essay, Rakoff takes particular
aim at the government's habit of prosecuting corporations, but not their
executives - a trend
we railed against earlier this year.
"Companies do not commit crimes," Rakoff
observes; "only their agents do... So why not prosecute the agent who
actually committed the crime?"
He's witheringly skeptical of prosecutions
of corporations, which usually yield some nominal fines and an agreement
that the company set up an internal "compliance" department.
"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."
Rakoff's at his best when analyzing why the
government has stopped pursuing individuals and taken the easy route of
settling with corporations.
He notes that this is a recent trend: In the
1980s, the government convicted more than 800 individuals, including top
executives, in the savings-and-loan scandal, and a decade later
successfully prosecuted the top executives of Enron and
He dismisses the Department of Justice
rationale that proving "intent" to defraud in the financial crisis cases
is difficult: There's plenty of evidence in the public record that
banking executives knew the mortgage securities they were hawking as AAA
He doesn't buy the excuse that criminal
prosecutions involving major financial firms might have damaged the
economy - no one has ever contended that a big firm would collapse just
because its high-level executives were prosecuted. And he notes that the
government doesn't dispute that some of these executives may be guilty -
it just comes up with excuses for not prosecuting.
Why? Rakoff posits that there are several
reasons for the lack of prosecutions.
One is that the
FBI and SEC are both understaffed because of budget cuts, and in the
FBI's case with the diversion of much of its workforce to anti-terrorism
after 9/11. And he speculates that the
government may feel abashed at its own complicity in the crisis, arising
from the easing of financial and mortgage regulations over the years.
Rakoff's piece has elicited some predictable
push-back from the Department of Justice, where a spokesman scoffed that
"does not identify a single case where a
financial executive should have been charged, but wasn't."
This is a cynical defense at best, since the
DOJ knows well that for Rakoff to have prejudged a case by naming
names would have been a flagrant breach of judicial ethics.
Indeed, Rakoff takes pains to disavow any
opinion about whether criminal fraud was committed "in any given
But he does point out that evidence of
fraudulent behavior is not hard to find - the
report of the Financial Crisis Inquiry Commission headed by former
California Treasurer Phil Angelides brims with documented
What's been lacking, Rakoff finds, is the
political will and government resources to bring individuals before the
bar of justice.
Although millions of Americans are still
suffering the financial consequences of the crisis, Rakoff suggests that
the failure of the justice system may do even more lasting damage to the
fabric of American society.
His warning should be heeded, before it's
The Financial Crisis
Why Have No High-Level Executives Been Prosecuted?
by Jed S. Rakoff
The New York Review of Books
January 9, 2014 Issue
Five years have passed since the onset of what is sometimes called the
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
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
For example, the Financial Crisis Inquiry
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
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
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
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
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
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:
they have argued that proving fraudulent intent on the part of the
high-level management of the banks and companies involved has been
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
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
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.
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
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
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
- 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
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
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.
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
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
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.
the prosecutors had other priorities. Some of these were completely
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
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
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
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
- 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
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
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 (OTS),
having just finished a successful campaign to preempt state
regulation of thrift underwriting, terminated its own underwriting
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,
If, in the process, mistakes were made
and liabilities not disclosed, was it not partly the government's
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
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 a CEO who might, with some justice, claim that he
was only doing what he fairly believed the government wanted him to
- The final (third)
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
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
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
"non-prosecution 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
With his help, and aided by the substantial
prison penalties now available in white-collar cases, you go up the
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
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
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
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
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.