I suppose we poor suffering ordinary citizens should be pleased to see any prosecutions directed at those at the top of the food chain. The Wall Street Journal reports that the former head of McKinsey, Rajat Gupta, is facing criminal charges in the Galleon insider trading case. It’s such a rare event for a business figure of the stature of Gutpa to be charged (he was on the boards of Goldman and the Gates Foundation) that it is now the lead story on the New York Times front page.
But that is what is wrong with this picture. Given the level of criminality in the top echelons in the US, we should see a lot more in the way of prosecutions. And the Wall Street Journal contends that the case against Gupta would break new ground, since he did not profit in any direct manner from his tips:
The expected charges against Mr. Gupta are likely to reveal that the government believes that insider trading doesn’t always involve swapping information for money. Mr. Gupta isn’t alleged to have received any money or direct benefits from Mr. Rajaratnam in exchange for corporate secrets, a potential weakness in the prosecutors’ case Mr. Gupta’s lawyer is likely to seize on.
The government is expected, however, to argue that the relationship between the two men, who socialized and invested together, is emblematic of the back-scratching that pervades the corporate world and can sometimes veer into insider trading.
Note the New York Times differs a tad:
While there has been no indication yet that Mr. Gupta profited directly from the information he passed to Mr. Rajaratnam, securities laws prohibit company insiders from divulging corporate secrets to those who then profit from them.
Regardless of whether the legal argument is a bit aggressive or not, notice that the SEC is moving boldly on these cases when it has sorely neglected other beats. Let’s face it: insider trading cases are comparatively easy to prove, and the SEC likes to go after low hanging fruit.
Many people, including your humble blogger, have criticized the SEC for doing close to nothing as far as attacking abuses in mortgage securitizations and CDOs. We’ve also argued that they dropped a promising avenue for getting criminal (stress criminal) prosecutions of Wall Street executives by an apparent misreading of a ruling in their case against Angelo Mozilo.
But as much as the SEC’s timidity and learned incompetence is frustrating, it is not entirely the agency’s fault. It has been repeatedly hounded by Congress at least as early as the Clinton era, when the agency was interested merely in protecting consumers. How exactly do you think Congresscritters would react if SEC actions regularly implicated the banks that are among their biggest meal tickets? Since Congress controls the SEC’s budget, it can and has hamstrung the SEC. An occasional action to preserve the agency’s image might be tolerated, but anything beyond that is certain to lead to retaliation.
I don’t know if the SEC can ever be restored to being the respected and feared body it was in the 1970s and early 1980s. I’d have said impossible, but recall that the Commie-bashing 1950s were followed by the big social changes of the 1960s. We may be in the early stages of a similar large change in the zeitgeist, which means major changes in institutional behavior could occur down the road.
Update 3:10 PM: Aargh, the perils of AM drafting when I am a little too keen to turn in. Reader LucyLulu correctly points out that I failed to mention that only the DOJ can file criminal cases. As I stated in comments I should have included material from the older post I linked to that that there is a VERY clear path under Sarbanes Oxley from civil to criminal cases. If you win certain types of civil Sarbox cases, the criminal case follows virtually directly. And the area in which Wall Street is vulnerable is that Sarbox requires certain executives to certify the adequacy of internal controls, which for Wall Street can easily be argued to include risk management. We’ve written as to how obviously defective and politically compromised risk management is at major banks. You have further issues at some firms. For instance I’ve been told that Lehman didn’t even know how many open derivatives positions it had at the time of its collapse. They ran on multiple systems (with “multiple” being a large number, not two or three) with no effective structure over them for aggregation. If this is true, it’s a stunning lapse. It would be easy, indeed, predictable, for large mistakes to occur.
So the bit of the argument omitted was that the SEC could have filed more Sarbox cases and then relied their visibility to pave the way for the related criminal case. The SEC seems to have started down that path, and in the post we linked to, it appears to have been deterred by a ruling (with no explanation) from the judge, which we read as having far more narrow implication that the SEC appears to think it had.