Looking Back on the Prosecution Failures after the 2008 Wall Street Crash

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by James A. Kidney, Wall St On Parade:

As the nation approaches the 10th anniversary of the demise of Lehman Brothers, which is popularly pegged as the beginning of the Great Recession, one is struck by the current events that tie back to the world-wide financial crisis of a decade ago.

John McCain again is in the headlines, this time more sadly, as he was when he made a Hail Mary move by temporarily “suspending” his presidential campaign to address the financial crisis — an ill-considered action he came to regret.

Big Wall Street banks are as up to their necks in risky derivatives, as in 2008.

Once again, the political powers are reveling in a long bull market and listening to wealthy bankers proclaim a pressing need to be relieved of minimal regulation.

In the view of some, current threats to the market economy are reminiscent of 2008, along with pollyannaish predictions from lawmakers and regulators from the White House on down that all is sound.

To one who was a bit player trying to enforce the securities law against these same banks and bankers after the crash, the most jarring developments relate to the law enforcement and media interest in conspiracy theories involving President Trump and his cronies.

These developments cause me once again to regret that such interest in conspiracy – a “scheme to defraud” in securities law circles – was not demonstrated by the media and, especially, by law enforcement, beginning 10 years ago.

Driving this home to me was that my old boss, Robert Khuzami, announced on behalf of the U.S. Attorney’s office the plea with former Trump lawyer Michael Cohen, a plea which clearly sounds like a conspiracy to violate campaign laws and the product of a lot of hard work by prosecutors.

Khuzami is now a deputy U.S. attorney for the Southern District of New York, after a stint with a large law firm. But he was the director of the Division of Enforcement of the Securities and Exchange Commission from 2009 to 2013, when several Wall Street banks were subjected to fines for their conduct bringing on the 2008 crash, but no senior, or even middle level, individuals were sued for violating the securities laws.

I was one of several trial lawyers at the SEC involved in the Commission’s investigations into conduct of the big banks and their employees. I can say, based on my experience and that of other trial lawyers, that there was an inexplicable reluctance on the part of the Division of Enforcement to utilize conspiracy theories to investigate – let alone sue – higher ups at Goldman Sachs, Bank of America, Morgan Stanley and other large banks.

Yet, it was obvious to many talented lawyers at the SEC, both senior and junior, that the products offered by these banks to investors were developed cooperatively and approved by knowledgeable men (almost exclusively men) of Wall Street far above the levels of those few who were unfortunate enough to be sued. It is very likely that at least some participated in a scheme to defraud – a conspiracy. But the Division of Enforcement under Khuzami chose to pursue cases almost exclusively on a much narrower “false statement” theory, which courts have increasingly interpreted to mean liability solely for the individual who actually misrepresented to an investor a fraudulent product. In effect, the SEC applied at the outset the narrowest legal theory available to restrict the investigation and, therefore, protect higher-ups from questioning, let alone possible charges. Conspiracy theories were rejected at the outset of most investigations and not pursued.

Let me be clear. We cannot know if higher ups on Wall Street were civilly liable for – or criminally guilty of – a scheme to defraud under the securities laws, i.e., a conspiracy. There was no stomach for investigating such liability, so any such conclusions are lost to history. Lessons that could have been learned for the next time are lost. There will be a next time.

Jesse Eisinger, a reporter for ProPublica, has compiled a narrative of the failure of the SEC and the Department of Justice to bring actions against individuals employed by the biggest Wall Street banks. It is available in his book, The Chickens**t Club. (Full disclosure: I am mentioned in one chapter.)

I have never heard any reason why conspiracy –scheme to defraud – theories were not considered at least as a reason to further investigate. The only answer I am aware of is that the leadership of the SEC and the Division of Enforcement have said they are “proud” of the work they did.

The issue was not one of resources at the SEC. The Division of Enforcement spent substantial amounts of money, assigned a large staff, and aggressively pursued individual executives at the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), who Republicans blamed for the crash to deflect blame from Wall Street. I was assigned to the Fannie Mae investigation, and am friends of staff who were on the Freddie Mac case. As these investigations proceeded, there was much skepticism that these institutions and their senior executives knowingly had engaged in fraud. The evidence of liability was very thin, but the cases were pressed ahead at substantial cost to the agency. The SEC brought suits in both cases in late 2011 against the individual executives alleging fraud based on the mortgage securities business. Since these firms were in federal receivership, the taxpayer, in effect, paid for both the SEC costs and those of defending Fannie and Freddie.

But little was said a few years later when relatively light settlements were agreed upon. Those knowledgeable of such things recognized the settlements were a way for the SEC to drop the Fannie and Freddie matters without any findings of liability. In other words, the SEC resolved the cases with its legal tail between its legs.

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