In my first year of law school I learned why enforcement of criminal and civil law is essential for the United State’s social and economic functioning. Apparently, the elite lawyers of the Bush Administration didn’t learn the same lesson since they have a non-existent enforcement policy which has made the US financial markets a Petri dish of illegal and immoral behavior. The SEC, Justice Department and banking regulators’ tolerance for unethical business behavior and blatant disregard for the law is the root cause of the current credit crisis. Without a radical change in enforcement policy by the next President, the last 7 years of mistakes will be repeated.
Blatant disregard for law and regulation is SOP for banks and brokerages. As the financial crisis unfolds and trillions of dollars are lost, it is clear that bankers can engage in commercial, securities or banking fraud without fear of prosecution or civil retribution. For example, in the last few weeks we have learned that IndyMac management organized Saturday work sessions for employees to inflate appraisals on loans that didn’t meet market standards. In mid-July, the Federal Reserve felt they had to tell sub-prime mortgage originators that coercion of appraisers is no longer acceptable (coercion appears to remain OK for prime mortgage originators). There hasn’t been a major Sarbanes-Oxley or 10b-5 enforcement action in years even though many banks and brokers regularly lie to shareholders and lack internal controls. And, despite these and other issues there has been no announcement of meaningful prosecution at any level and the Bush Administration hasn’t assumed a position of leadership on these issues.
In law school I learned that there are three principal reasons for criminal laws and enforcement. Set forth below is a brief discussion each of these objectives so we can start to remember why being a nation that respects laws is important.
- Deterrence. Everyone who went to elementary school and saw some kid made an “example of” by the teacher understands why deterrence works and how it should be applied. When deterrence is lacking, society engages in a “race to the bottom” as bullies and unethical people assert authority. IndyMac wouldn’t have forged documents if their employees thought there was a realistic chance that they would be prosecuted and spend time in prison. SEC filings would have full and fair disclosure if directors and officers believed that their freedom was at stake for “forgetting” to disclose business or financial risks. And, we wouldn’t have the Federal Reserve telling mortgage originators the obvious, that coercion isn’t acceptable, if prosecutors were doing their job and indicting anyone who tampers with, or creates fraudulent, appraisals, applications or loan documents. No deterrence has resulted in useless SEC reporting and abuse of investor and borrower trust.
- Retribution. Society wants and needs “bad guys” to be punished. If the criminal law system doesn’t work, populist politicians will legislate retribution and “mob justice” will be dispensed. The cathartic effect of active and fair criminal prosecution is needed to make all classes of society feel that everyone is treated equally and that “rich people” cannot commit financial crimes without consequence. At various times in United States history, mob justice has caused legislative overreaction that handicapped legitimate business interests and opportunities.
- Segregation. Violent criminals need to be segregated from society so they don’t hurt others. White collar criminals need to be separated from the organizations and tools that they used to commit their crimes so that they can’t perpetrate future financial frauds. Professional and businesses licenses are privileges and not rights. Such licenses are granted by the SEC, banking regulators, insurance regulators and professional organizations and can be lost in civil enforcement actions. During the 1980’s and 1990’s, in the fallout from the last bank and thrift crisis, many people lost their ability to work for banks, thrifts and brokers. So far, in the current crisis, there has been no effective civil enforcement or license suspension and perpetrators of bad acts and reckless judgment can re-invent themselves and come back to destroy new organizations and financial interests.
Free markets don’t mean corrupt markets. Honest companies have a tough time competing in a rigged market environment and we are all suffering from the Bush Administration’s almost complete lack of interest to enforce existing laws and regulations. Let’s hope the next President has some passion for the tough and detailed work of law enforcement and regulatory oversight.
Sunshine Notes » Blog Archive » TODAY I WAS ASKED “WHY ISN’T THE GOV’T PROSECUTING CORPORATE EXECUTIVES WHOSE COMPANIES HAVE MADE BAD DISCLOSURE TO SHAREHOLDERS?”
[…] As anyone who knows me realizes, I have been a constant critic of both the Bush administration and the banking and securities regulatory agencies. I have spoken out on TV and I have written about this issue in my blog. As I wrote on August 3rd […]