WILL HEAVY FINES DETER WALL STREET MISDEEDS?

 

By Ronald Fox

A reader, responding to my posting on economic inequality and institutional corruption, sent me a note asking whether I thought expanding civil and criminal probes into the financial dealings of Wall Street firms represents a turning point in holding large corporations accountable for criminal misconduct. These investigations, which have touched on such misdeeds as mortgage and derivative fraud, inner-bank interest rate manipulation, energy trading practices, insider trading, rigging global interest and currency rates, and passing out bribes to secure business, have already resulted in some record fines. The federal government promises there’s more to come. Globally the cost of banks cleaning up misdeeds is expected to soar to over $125 billion. I’m far from an expert on human behavior, business practices, and complex legal maneuverings, so in responding to the reader all I can offer is an educated opinion. I will draw on practical wisdom to argue that I don’t believe fines alone will be enough to deter Wall Street malfeasance.

The current legal troubles of JP Morgan Chase (henceforth, JPM), long considered one of our strongest and best managed financial institutions, is illustrative of recent government efforts to investigate and punish financial institution malfeasance. JPM is currently facing dozens of federal and state legal probes. As reported in the New York Times, a couple of foreign governments have also launched investigations. The company has already paid over $5 billion to resolve Federal claims that it misled Fannie Mae and Freddie Mac about risky home loans and securities they bought before the housing market collapsed, nearly $1 billion for failure to oversee trading that led to a $6 billion loss in its “London Whale” caper, and $410 million in a settlement with the Federal Energy Regulation Commission (FERC) for its alleged manipulation of California’s electricity market from 2010 to 2012. Among other legal probes, Morgan is presently being investigated for its connection to the Barnard Madoff Ponzi scheme and is in the final stages of negotiations with the U.S. Justice Department on a multi-billion dollar settlement for activities related to the financial crisis. Our “best managed financial institution” appears now to be possibly our biggest corporate crook.

Several other large banks and hedge funds have similar legal troubles, for which they have paid, or will likely soon pay, substantial fines. For example, on November 4, federal prosecutors announced that the giant hedge fund company, SAC Capital Advisers, agreed to plead guilty to insider trading violations and pay a record $1.2 billion penalty. Although federal authorities have not been able to build a case against SAC’s billionaire owner, Steven A. Cohen, the company did confess to criminal conduct, the first Wall Street firm to do so in several years.  

So, does all this legal maneuvering mean justice is finally prevailing? Are we entering a new era where corporate misdeeds will be effectively policed and thus deterred? I’d like to think so, but I must admit to remaining skeptical.

First of all, it must be said that the fines, while large compared to past penalties, are nothing these economic behemoths can’t handle. JPM, for instance, earned $97 billion in revenue in 2012, and has over $2.4 trillion in assets. Moreover, it should be noted that as a civil (not criminal) penalty, much of the fines will be tax deductible, seriously lessening the financial pain of the punishment.  Nevertheless, this is real money, even for a trillion-dollar bank, and federal prosecutors should be applauded for due diligence.

I don’t believe fines alone, however, even big ones, are sufficient sanctions to deter future malfeasance. They need to be accompanied by more severe penalties, like being prohibited from engaging in the kind of high risk business practices that got them in legal trouble in the first place. Such a prohibition was placed on SAC, which was forced to terminate its business of managing money for outside investors. Such punishments, while noteworthy, however, are still not enough. Until top corporate executives are held personally responsible for criminal activity perpetrated under their watch, we cannot expect any significant reduction in corporate law breaking.  Prosecution could have a double benefit: punishing law breakers, and helping restore public faith in the rule of law, which has been severely tarnished by the legal double standard that has kept Wall Street, and other white collar, crooks out of jail.

I realize that figuring out who ordered the dirty deals and carried them out is no easy task when it comes to large, highly complex institutions. When an ax does come down, it usually falls on some mid-level employees: the proverbial “bad apples” top executives like to point to. In Manhattan last week, Federal prosecutors accused two such mid-level JPM traders of cooking the books in last year’s London Whale trading fraud by allegedly trying to hide losses resulting from risky derivative bets that backfired. It appears they did, but under whose orders? We all know in our heart of hearts that mid-level personnel don’t do such things on their own initiative. Someone higher up gave direction, either directly or implicitly.

Not surprisingly, it’s the possibility of criminal prosecution that top executives are most fearful of and determined to fight, for not only might it mean jail time, but would likely bring on an endless wave of lawsuits for damages by investors, and even other corporations, victimized by fraudulent activities. Morgan CEO, Jamie Dimon’s determination to exempt company top officials from criminal liability seems to be what is holding up finalization of the preliminary $13 billion settlement over JPM’s mortgage bond fraud. Dimon wants Justice to agree to end investigations into whether Morgan purposely misled investors when it bundled subprime bonds before the financial crisis.

This may be a hard sell, since it has been reported that prosecutors in Sacramento believe they have established the personal link that could support criminal indictments of JPMorgan Chase executives. We’ll see what happens. It’s a good thing that Attorney General Eric Holder and his prosecutors have so far refused to drop potential criminal charges and settle for bigger money, which is what Dimon is shooting for. The preliminary deal reached last month for $13 billion did not take criminal investigation off the table. Let’s hope any final deal doesn’t as well.

No high level Wall Street executives have yet been sent to jail for misdeeds during the financial crisis. Few have even been forced to admit or deny misconduct as part of a settlement, including JPM in its FERC Commission settlement. This unfortunate state of affairs has to stop. Criminal prosecution of a top executive would be the kind of action that would possibly motivate Wall Street movers and shakers to change the way they conduct business. As they say in the business, it could be the “game changer.” The Supreme Court has given corporations the same rights as individual American citizens. As citizens, shouldn’t they also have responsibilities?

NOTE: In previous postings on economic inequality, Charles and I have tried to make a connection between America’s wide disparity in wealth and leadership failure, institutional corruption, individual cheating, and the erosion of the American dream. The ability of Wall Street executives to escape criminal prosecution for law breaking underscores another consequence of skewed wealth: legal inequality. It appears our biggest Wall Street financial institutions are not only “too-big-to-fail,” but their executives “too-big-to-jail.” What remains to us to connect is probably the most insidious consequence of economic inequality: political inequality. I’ll touch on this challenge to democratic ideals in an upcoming essay.