Authors: Charles Ferguson
With all that, they must have suspected something—and indeed they did. The lawsuit filed by the Madoff bankruptcy trustee against JPMorgan Chase makes for astonishing reading. More than a
dozen senior JPMorgan Chase bankers had discussed in e-mails and memoranda, as well as in person with each other, a long list of suspicions. On 15 June 2007, one employee said to another: “I
am sitting at lunch with [redacted] who just told me that there is a well-known cloud over the head of Madoff and that his returns are speculated to be part of a Ponzi scheme.” At the same
time—June 2007—three members of JPMorgan Chase’s executive committee openly discussed this possibility at a meeting. They were John J. Hogan, chief risk officer for investment
banking; Matthew E. Zames, a senior trading executive; and Carlos M. Hernandez, head of equities for the investment banking unit. After Madoff’s arrest, Hogan’s deputy, Brian Sankey,
suggested that it would be preferable if the meeting agenda “never sees the light of day again.”
34
But Madoff produced a half billion
dollars in fee revenue for JPMorgan over the years.
The SEC has been deservedly criticized for not following up on years of complaints about Madoff, many of which came from a Boston investigator, Harry Markopolos, whom they treated as a crank.
The SEC also bungled its own investigations of Madoff. But suppose a senior executive at Goldman Sachs, UBS, or JPMorgan Chase had called the SEC director of enforcement and said, “You really
need to take a close look at Bernard Madoff. He must be working a scam. No proof, but here are five very suspicious facts, and here’s what you should look for.” If it came from them,
the SEC would have had to pay attention, even in the pitiful, toothless state to which it had been reduced in the Clinton and
Bush administrations. But not a single bank that
had suspicions about Madoff made such a call. Instead, they assumed he was likely a crook, but either just left him alone or were happy to make money from him.
The Financial Crisis as the logical Culmination of Financial Criminalization
TAKEN TOGETHER, THE
foregoing suggests a major cultural change in global banking, and in its treatment by regulators and law enforcement
authorities. Since the 1980s finance has become more arrogant, more unethical, and increasingly fraudulent. Tolerance of overtly criminal behaviour has now become broadly,
structurally embedded in the financial sector, and has played a major role in financial sector profitability and incomes since the late 1990s. In some cases, financial misbehaviour has supported
truly grave offences (nuclear weapons proliferation), while in other cases it has been a major contributor to financial instability and recession (the S&L crisis, the Internet bubble).
And yet none of this conduct was punished in any significant way. Total fines for all these cases combined appear to be far less than 1 percent of financial sector profits and bonuses during the
same period. There have been very few prosecutions and no criminal convictions of large US financial institutions or their senior executives. Where individuals not linked to major banks have
committed similar offences, they have been treated far more harshly.
Given this background, it is difficult to avoid the conclusion that the mortgage bubble and financial crisis were facilitated not only by deregulation but also by the prior twenty years’
tolerance of large-scale financial crime. First, the absence of prosecution gradually led to a deeply embedded cultural acceptance of unethical and criminal behaviour in finance. And second, it
generated a sense of personal impunity; bankers contemplating criminal actions were no longer deterred by threat of prosecution.
My own conclusion after having examined this subject is that if the
Internet bubble, the abetting of frauds at Enron and elsewhere, and the money-laundering scandals had
resulted in prison sentences for senior financial executives, the financial crisis probably would have been far less serious, even if financial deregulation had occurred just as it did at the
policy level. The law still leaves considerable scope for dangerous and unethical behaviour, but many of the abuses of the bubble depended upon criminality.
And just as the last twenty years of unpunished crime constituted a green light for the bubble, so, too, the nonresponse to the bubble and crisis is setting the tone for financial conduct over
the next decade. Beyond an interest in justice for its own sake, it is therefore important to consider whether the behaviour that generated the bubble was criminal, whether successful prosecutions
are feasible under US law, and whether putting senior financial executives in prison on a large scale would be ethically justified and economically beneficial.
The Obama administration has rationalized its failure to prosecute anyone (literally, anyone at all) for bubble-related crimes by saying that while much of Wall Street’s behaviour was
unwise or unethical, it wasn’t illegal. Here is President Obama at a White House press conference on 6 October 2011:
Well, first on the issue of prosecutions on Wall Street, one of the biggest problems about the collapse of Lehmans [sic] and the subsequent financial crisis and the whole
subprime lending fiasco is that a lot of that stuff wasn’t necessarily illegal, it was just immoral or inappropriate or reckless. That’s exactly why we needed to pass Dodd-Frank, to
prohibit some of these practices. The financial sector is very creative and they are always looking for ways to make money. That’s their job. And if there are loopholes and rules that can
be bent and arbitrage to be had, they will take advantage of it. So without commenting on particular prosecutions—obviously that’s not my job; that’s the Attorney
General’s job—I think part of people’s frustrations, part of my frustration, was a lot of practices that should not have been allowed weren’t necessarily against the
law.
35
In these and many other statements, the president and senior government officials have portrayed themselves
as frustrated and hamstrung—desirous of punishing those responsible for the crisis, but unable to do so because their conduct wasn’t illegal, and/or the US government lacks
sufficient power to sanction them. With apologies for my vulgarity, this is complete horseshit.
When the federal government is really serious about something—preventing another 9/11, or pursuing major organized crime figures—it has many tools at its disposal and often uses
them. There are wiretaps and electronic eavesdropping. There are undercover agents who pretend to be criminals in order to entrap their targets. There are National Security Letters, an aggressive
form of administrative subpoena that allows US authorities to secretly obtain almost any electronic record—complete with a gag order making it illegal for the target of the subpoena to tell
anyone about it. There are special prosecutors, task forces, and grand juries. When Patty Hearst was kidnapped by the radical Symbionese Liberation Army in 1974, the FBI assigned hundreds of agents
to the case.
In organized crime investigations, the FBI and government prosecutors often start at the bottom in order to get to the top. They use the well-established technique of nailing lower-level people
and then offering them a deal if they inform on and/or testify about their superiors—whereupon the FBI nails their superiors, and does the same thing to them, until climbing to the top of the
tree. There is also the technique of nailing people for what can be proven against them, even if it’s not the main offence. Al Capone was never convicted of bootlegging, large-scale
corruption, or murder; he was convicted of tax evasion.
In this spirit, here are a few observations about the ethics, legalities, and practicalities of prosecution related to the bubble:
First, much of the bubble
was
directly, massively criminal. One can debate exactly what fraction, where the grey areas are, how much of it can be proven, and so forth. But it sure as hell
wasn’t zero. And we’ll take another little tour of the industry shortly, with this question in mind.
Second, if you really wanted to get these people, you could. Maybe not all of them, but certainly many. Some bubble-related violations are very clear, with strong written
evidence. If you flipped enough people, some of them would undoubtedly have interesting things to say about what their senior management knew. And many of the people responsible for the bubble are
the same people responsible for the other activities we just examined that have not been seriously pursued or punished. Some of these people have also committed various personal offences—drug
use, use of prostitution, tax evasion, insider trading, fraudulent billing of personal spending as business expenses. Many of them still have their original jobs and are therefore subject to
regulatory oversight and pressure, as are their firms. In fact, there are many techniques, venues, organizations, regulations, and statutes, both civil and criminal, available to investigate these
people, punish them, and recover the money they took—if one really wanted to. The US government has used almost none of them.
Third, the moral argument for punishment is very strong, providing ample justification for erring on the side of aggressive legal pursuit. Whatever portion of banking conduct during the bubble
was criminal, it was certainly substantial, and there is no doubt whatsoever that it was utterly, pervasively unethical, designed to defraud in reality if not in law. Since the crisis, the people
who caused it have been anything but honest or contrite. They have often been evasive, dishonest, and self-justifying, returning as quickly as possible to their unerringly selfish behaviour. Their
behaviour caused enormous damage, both human and economic; the consequences of their wrongdoing are so large as to justify almost any action that could help to prevent another such crisis by
creating real deterrence. There would also be intangible but large benefits to raising the general ethical standard of a vital industry, and one whose executives often become high-level government
officials.
Given this background, let’s now consider the question of criminal liability, as well as the feasibility of prosecution.
J’accuse
A REASONABLE LIST
of prosecutable crimes committed during the bubble, the crisis, and the aftermath period by some financial services
firms includes:
• Securities fraud (many forms)
• Accounting fraud (many forms)
• Honest services violations (US mail fraud statute)
• Bribery
• Perjury and making false statements to US federal investigators
• Sarbanes-Oxley violations (certifying false accounting statements)
• RICO (Racketeer Influenced and Criminal Organizations Act) offences and criminal antitrust violations
• Federal aid disclosure regulations (related to Federal Reserve loans)
• Personal conduct offences (many forms: drug use, tax evasion, etc.)
In addition, financial sector firms and executives committed many civil offences for which they could be pursued in civil actions, which have a lower burden of proof (a preponderance of
evidence, as opposed to “beyond a reasonable doubt” required in criminal judgements). These offences include civil Sarbanes-Oxley violations, civil fraud, and violations of multiple SEC
regulations, particularly regulations related to disclosure requirements.
Let’s consider some examples.
Securities Fraud
Here, we face an embarrassment of riches. The primary applicable authority is US Rule 10b-5, promulgated by the SEC under the authority of the 1934 Securities Exchange Act. It
reads:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of
any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the
circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale
of any security.
There are several essential elements to a 10b-5 offence: it must be a
misstatement or omission
that is sufficiently
material
to affect an investor’s opinion; that is made
intentionally;
that the investor
relied upon
in making his decision; and that directly caused
actual losses
. The rule can be used by the SEC for bringing civil cases, by the US
Justice Department for both civil and criminal actions, and also by private parties bringing civil suits. Even if the securities in question are being sold to sophisticated, professional investors,
you can’t lie to them.
Where to begin?
As we have already seen, almost all the prospectuses and sales material on mortgage-backed bonds sold from 2005 through 2007 were a compound of falsehoods. But it starts even earlier in the food
chain. We have
also
already seen that mortgage originators committed securities fraud when they misrepresented the characteristics of loan pools, and the nature and extent of their due
diligence with regard to them, when they sold pools to securitizers (and accepted financing from them). Most or all of the securitizers (meaning nearly all the investment banks and major banking
conglomerates) then committed securities fraud when they misrepresented the characteristics of loans backing their CDOs, the characteristics of the resulting mortgage-backed securities, and the
nature and results of their due diligence in the process of
creating those CDOs. The securitizers also committed securities fraud when they made similar misrepresentations to
the insurers of, and sellers of CDS protection on, those CDOs.