Absent sitting on the Supreme Court, it is difficult for a single judge to effect much change. Yet Jed Rakoff, in sending the SEC back to the woodshed in two separate cases over its failure to get factual admissions, meaning admissions of misconduct, on civil settlements of SEC cases, singlehandedly embarrassed the SEC and the Department of Justice into seeking these statements (for instance, numerous media reports indicate that the Administration wants that sort of confession as part of its pending settlement with JP Morgan).
Rakoff threw down another gauntlet in a New York Bar Association speech on Tuesday. I’m taking the liberty of quoting it at length because his rebuke is a breath of fresh air and roused the Department of Justice to issue a “we really are doing our job” response.
But if, by contrast, the Great Recession was in material part the product of intentional fraud, the failure to prosecute those responsible must be judged one of the more egregious failures of the criminal justice system in many years.
Rakoff then pointed to the fact that the FCIC and numerous government officials had discussed fraud in connection with the crisis and went further:
While officials of the Department of Justice have been more circumspect in describing the roots of the financial crisis than have the various commissions of inquiry and other government agencies, I have seen nothing to indicate their disagreement with the widespread conclusion that fraud at every level permeated the bubble in mortgage-backed securities.
He then goes through their litany of excuses (his word). Ooh, it’s hard to pin fraud on top executives in big complex companies! Poppycock, says Rakoff:
Who, for example, were generating the so-called “suspicious activity” reports of mortgage fraud that, as mentioned, increased so hugely in the years leading up to the crisis? Why, the banks themselves. A top level banker, one might argue, confronted with increasing evidence from his own and other banks that mortgage fraud was increasing, might have inquired as to why his bank’s mortgage-based securities continued to receive triple-A ratings? And if, despite these and other reports of suspicious activity, the executive failed to make such inquiries, might it be because he did not want to know what such inquiries would reveal?
This, of course, is what is known in the law as “willful blindness” or “conscious disregard.” It is a well-established basis on which federal prosecutors have asked juries to infer intent, in cases involving complexities, such as accounting treatments, at least as esoteric as those involved in the events leading up to the financial crisis. And while some federal courts have occasionally expressed qualifications about the use of the willful blindness approach to prove intent, the Supreme Court has consistently approved it.
The second, “weaker” excuse came out of Lanny Breuer’s mouth in his notorious Frontline interview: that the investors in mortgage-backed securities were sophisticated; it would be hard to prove they relied on ratings and fraudulent misrepresentation. Rakoff basically says that Breuer is a crappy lawyer:
Actually, given the fact that these securities were bought and sold at lightning speed, it is by no means obvious that even a sophisticated counterparty would have detected the problems with the arcane, convoluted mortgage-backed derivatives they were being asked to purchase. But there is a more fundamental problem with the above-quoted statement from the former head of the Criminal Division, which is that it totally misstates the law. In actuality, in a criminal fraud case the Government is never required to prove reliance, ever. The reason, of course, is that would give a crooked seller a license to lie whenever he was dealing with a sophisticated counterparty. The law, however, says that society is harmed when a seller purposely lies about a material fact, even if the immediate purchaser does not rely on that particular fact, because such misrepresentations create problems for the market as a whole.
The third excuse is that prosecution might hurt the economy. Rakoff indicated his discomfort with the “too big to jail” idea, but used that to lambaste the notion of prosecuting institutions as opposed to individuals. No institution would perish if an executive were prosecuted.
Rakoff carefully and pointedly says he’s not accusing prosecutors of revolving-door corruptions and that prosecutors maximize their value in the post-government service market by collecting scalps. Whether of not he actually believes that to be true, he has to say that or risk never hearing a big securities case ever again, in that both defendants and regulators could ask to have cases assigned to other judges based on the notion that Rakoff had said that prosecutors were soft of big corporate crime because they were currying favor with prospective future employers. Notice, by contrast, the cautionary example of Judge Shira Scheindlin, who had a ruling opposing New York City’s stop and frisk rules overturned because she violated the code of conduct for Federal judges by showing partiality.
But he point out other reasons why no one could be bothered to go after the conduct that wrecked the economy. The best US Attorney’s office, the Southern District of New York, was busy on the Rajaratnam case. Any smart prosecutor would ride that horse, which was ready to go, rather than take on the slog of a case that was years away from being files. So basically, with Congress starving the SEC of budget and making it capable only of handing out parking tickets in the form of insider trading cases, SDNY staffers were incentivized to go after the comparatively easy cases the SEC threw over the transom rather than pursue far more important crisis-related cases. Rakoff argues the other reason for the government’s reticence to prosecute is that it would embarrass government officials and expose policy failings.
And Rakoff described why prosecuting companies, rather than targeting individuals, produces lame outcomes:
But if your priority is prosecuting the company, a different scenario takes place. Early in the investigation, you invite in counsel to the company and explain to him or her why you suspect fraud. He or she responds by assuring you that the company wants to cooperate and do the right thing, and to that end the company has hired a former Assistant U.S. Attorney, now a partner at a respected law firm, to do an internal investigation. The company’s counsel asks you to defer your investigation until the company’s own internal investigation is completed, on the condition that the company will share its results with you. In order to save time and resources, you agree. Six months later the company’s counsel returns, with a detailed report showing that mistakes were made but that the company is now intent on correcting them. You and the company then agree that the company will enter into a deferred prosecution agreement that couples some immediate fines with the imposition of expensive but internal prophylactic measures. For all practical purposes the case is now over. You are happy because you believe that you have helped prevent future crimes; the company is happy because it has avoided a devastating indictment; and perhaps the happiest of all are the executives, or former executives, who actually committed the underlying misconduct, for they are left untouched.
I suggest that this is not the best way to proceed. Although it is supposedly justified in terms of preventing future crimes, I suggest that the future deterrent value of successfully prosecuting individuals far outweighs the prophylactic benefits of imposing internal compliance measures that are often little more than window-dressing. Just going after the company is also both technically and morally suspect. It is technically suspect because, under the law, you should not indict or threaten to indict a company unless you can prove beyond a reasonable doubt that some managerial agent of the company committed the alleged crime; and if you can prove that, why not indict the manager? And from a moral standpoint, punishing a company and its many innocent employees and shareholders for the crimes committed by some unprosecuted individuals seems contrary to elementary notions of moral responsibility.
On the one hand, it’s good to see Rakoff again rattling cages. On the other, it’s disheartening that the comparatively restrained remarks of a Federal judge serve as bold talk. It’s yet another reminder of how candid discussion of fraud and criminal conduct in the crisis has been successfully mislabled by a lapdog media as naive or ill informed.
If you are a Rakoff fan, he’s moderating a panel at Columbia Law School on Friday whose members include Neil Barofsky and John Coffee. I’m told it’s open to the public.