HOW MONEY IS CORRUPTING OUR POLITICS

ABSTRACT: Huge contributions and expenditures from wealthy special interests were front and center in the 2012 campaigns because of the unlimited spending allowed by the Supreme Court’s Citizens United decision. The 32 biggest donors to Super PACs spent as much money as the total of all the donations by the 3.7 million Americans who made small donations to the Obama or Romney campaigns.

The Open Secrets project of the Center for Responsive Politics (http://www.opensecrets.org/) investigates and reports on money in campaigns. It has now documented a web of over a dozen organizations that transferred money among themselves to hide the true sources of campaign spending, so-called “dark money.” Dark money has been used in state, local, and national campaigns. Adding an international element to the dark money issue, federal prosecutors say a Mexican businessman illegally funneled more than $500,000 into U.S. political races through Super PACs and various shell corporations.

The amounts of money that candidates for Congress have to raise for their campaigns is staggering. A member of the US House needs to raise, on average, $15,000 each and every week; a Senator needs to raise $33,000 every week. Time spent fundraising is time that doesn’t get spent working on legislation or listening to and representing average constituents.

The dominance of money in campaigns, and of wealthy special interests in providing this money, skews the priorities and policy positions of elected officials. It corrupts the making of public policy. Reforms of our campaign finance system are needed and can be done now (within the context of the Supreme Court’s rulings) that:

  • Amplify the voices of average citizens and their small contributions to campaigns,
  • Require timely reporting of all campaign spending and contributions, and
  • Severely limit political activity by tax exempt organizations.

FULL POST: Huge contributions and expenditures from wealthy special interests were front and center in the 2012 campaigns because of the unlimited spending allowed by the Supreme Court’s Citizens United decision. Private watchdog groups are continuing to trace and expose the sources and convoluted paths of money going from wealthy donors to campaign spending. This both exposes the donors (who often wish to remain secret) and illustrates the need for reform. Here are a few examples of their extensive findings.

The 32 biggest donors to Super PACs spent as much money as the total of all the donations by the 3.7 million Americans who made small donations to the Obama or Romney campaigns. [1] The two Koch brothers, billionaires due to their oil and industrial corporations, spent at least $400 million on campaigns in 2012, which is more than John McCain’s entire presidential campaign spent in 2008. [2] And fewer than 300,000 individuals (one-tenth of one percent of the 300 million Americans) provided the majority, roughly 60%, of the money raised by Congressional candidates from individuals. [3]

The Open Secrets project of the Center for Responsive Politics (http://www.opensecrets.org/) investigates and reports on money in campaigns. It has been digging into the money spent in the 2012 campaigns by Super PACs and social welfare groups (tax exempt 501(c)(4) organizations). It has now documented a web of over a dozen organizations that transferred money among themselves to hide the true sources of campaign spending, delay any reporting of it, and circumvent IRS limits on political activity by non-profit, tax exempt organizations. It has also documented that at least one quarter of the so-called “dark money” – money where the source was hidden – was linked to the two Koch brothers. [4]

Dark money was used in state as well as national campaigns. In California, an $11 million campaign contribution of dark money by a non-profit, tax exempt organization opposing a tax increase sparked an inquiry by the state’s Fair Political Practices Commission and a grand jury investigation into violations of campaign finance laws and money laundering. A judge forced the Americans for Responsible Leadership, the apparent source of the contribution, to reveal the original source of the money. The money had come from the Center to Protect Patient Rights, another Arizona non-profit, which received the money from Americans for Job Security, a Virginia non-profit. Both of these organizations are connected to the Koch brothers’ political money network. The organizations have agreed to disgorge the $11 million contribution and pay a record $1 million fine. The investigation also uncovered a separate $4.1 million illegal contribution that now will also be disgorged. California is working to improve disclosure of campaign contributions and strengthen laws and regulations to stop dark money activity. [5]

Dark money has arrived at the local level as well. In the recent Boston mayoral election, organizations independent of the candidates’ campaigns spent over $3.8 million, much of it dark money. This spending had a significant impact as it was more than two-thirds as much as the campaigns of the two finalists spent on their own ($5.4 million). As a result, Massachusetts elected officials are working on laws that would tighten regulation of campaign spending, and, in particular, require disclosure of all donors promptly, before the election, so voters would know who was responsible for the spending. [6][7]

Adding an international element to the dark money issue, federal prosecutors say a Mexican businessman illegally funneled more than $500,000 into U.S. political races through Super PACs and various shell corporations. This is the first known instance of a foreign national exploiting the Supreme Court’s Citizens United decision to spend money on U.S. elections. The allegations surrounding Jose Susumo Azano Matsura, the owner of multiple construction companies in Mexico, include bankrolling a handful of southern California candidates. The scandal involves a U.S. congressman, a Washington, D.C.-based campaign firm, and the consequences of the Citizens United decision. That decision, which gives corporations the right to funnel donations to US candidates, allowed Matsura to obscure the true source of the donations and, therefore, the citizenship of the donor. [8]

The amounts of money that candidates for Congress have to raise for their campaigns is staggering. In 2012, the average cost of a wining campaign for the House was over $1.6 million and over $10.4 million for the Senate. That means that a member of the House, who runs for re-election every two years, needs to raise, on average, $15,000 each and every week. And a Senator needs to raise, on average, $33,000 every week. Newly elected members of Congress are typically told to spend four hours each day raising money. Time spent fundraising is time that doesn’t get spent working on legislation or listening to and representing average constituents. [9]

The dominance of money in campaigns, and of wealthy special interests in providing this money, skews the priorities and policy positions of members of Congress, and other elected officials, to favor the wealthy and special interests over the common good. In other words, it corrupts the making of public policy. Democracy – government of, by, and for the people – is perverted by the current role of money in our political system, where big money drowns out the voices and overwhelms the interests of average citizens.

Reforms of our campaign finance system are needed and can be done now (within the context of the Supreme Court’s rulings) that:

  • Amplify the voices of average citizens and their small contributions to campaigns;
  • Require timely reporting of all campaign spending and contributions (including bundling), so that voters know before they vote where the money is coming from;
  • Limit contributions that elected officials can receive from interests they oversee, from political committees, and from lobbyists;
  • Prohibit fundraising by elected officials during normal working hours;
  • Severely limit political activity by tax exempt organizations and require them to report donors; and
  • Improve enforcement of existing campaign finance laws.

[1]       U.S. PIRG, 2/5/14, “US PIRG applauds the introduction of the Government by the People Act,” U.S. PIRG

[2]       Hight, C., 2/6/14, “Government by the people, not the polluters,” The Huffington Post

[3]       Lioz, A., Feb. 2014, “The Government by the People Act,” Demos (http://www.demos.org/publication/government-people-act)

[4]       Maguire, R., 12/3/13, “At least 1 in 4 dark money dollars in 2012 had Koch links,” OpenSecretsblog (http://www.opensecrets.org/news/2013/12/1-in-4-dark-money-dollars-in-2012-c.html)

[5]       Blumenthal, P., 10/24/13, “California settles ‘dark money’ case,” The Huffington Post

[6]       McMorrow, P., 11/12/13, “Citizens United comes to local races,” The Boston Globe

[7]       Levenson, M., 11/12/13, “Bill would order fast disclosure of donors,” The Boston Globe

[8]       ManfromMiddletown, 2/13/14, “This is how Citizens United dies,” Daily Kos (http://www.dailykos.com/story/2014/02/13/1277252/-This-is-How-Citizens-United-Dies#)

[9]       Jan, T., 5/12/13, “They go to lead, but courting cash is now job 1,” The Boston Globe

STOPPING THE CORRUPTION OF MONEY IN POLITICS

ABSTRACT: There’s good news on multiple fronts in the effort to stop the corruption of big money in US political campaigns. In the US House, the Government by the People Act (HR 20) has been introduced. It would match small donations – up to $150 – from individuals 6 to 1 so that, for example, a $25 donation would be worth $175 to a candidate running for Congress. In addition, every person who files an income tax return could get a $25 credit for small donations to Congressional candidates. A similar bill, the Fair Elections Now Act, has been introduced in the US Senate.

Meanwhile, last November, the IRS put out proposed regulations to severely limit political activity by tax exempt, non-profit organizations, which spent $300 million on political activities in the 2012 elections. Such regulations would be a huge step toward ending the huge amounts of “dark money” – where the source was hidden – that flowed into campaigns in 2012.

These reforms of our campaign finance system are a critical step in moving back toward the fundamental principle of one person, one vote. In the current system, it’s dollars that matter. In various ways, big donors buy election results. The Supreme Court has ruled that the money of the wealthy and corporations cannot be limited or regulated, because it is speech. Therefore, we must amplify the voices of the rest of us and require disclosure of all campaign contributions and spending. Otherwise, the integrity and legitimacy of our democracy is threatened, and people will justifiably conclude that the system is rigged and that their voices and interests are being drowned out by the money of wealthy individuals and corporations.

FULL POST: There’s good news on multiple fronts in the effort to stop the corruption of big money in US political campaigns. Bills have been filed in Congress to amplify and encourage the voices and money of small donors. The IRS has proposed rules that would require greater disclosure and limit political spending by tax exempt groups.

In the US House, the Government by the People Act (HR 20) has been introduced with 130 House members as co-sponsors (out of 435 total members). It would match small donations – up to $150 – from individuals 6 to 1 so that, for example, a $25 donation would be worth $175 to a candidate running for Congress.

To qualify for the matching funds, a candidate would have to raise $50,000 in contributions of $150 or less from at least 1,000 donors in their home state. The candidate could not accept contributions of more than $1,000, could not accept PAC money, and would be strictly limited in the use of their own money in the campaign.

In addition, every person who files an income tax return could get a $25 credit for small donations to Congressional candidates. (A similar tax credit existed from 1972 to 1986.) Disclosure laws would be tightened so the source of all contributions would have to be publicly disclosed. [1][2]

A similar bill, the Fair Elections Now Act, has been introduced in the US Senate. It shares the goal of super-sizing the influence of small donors and allowing candidates to run competitive races for Congress while relying on small donations from regular people.

You can get lots more information and all the details of these bills here (http://ofby.us/) and sign on as a citizen co-sponsor here (http://ofby.us/citizen-cosponsor/).

Forty groups have already endorsed this legislation: good government groups such as Common Cause, public interest groups such as the US Public Interest Research Group (PIRG), environmental groups such as the Sierra Club, labor unions such as the National Education Association and the Communications Workers of America, and civil rights groups such as the NAACP.

Campaign funding systems that match small contributions, as the bills in Congress would, are already in place in states from Maine to Arizona and in New York City. They amplify the voice of small donors and blunt the impact of large donations. This allows average citizens to run competitive campaigns. As a result, the number of people running and the competition for elected offices has increased where these matching systems are in place. This results in greater representation of the common interest and reduced influence for special interests.

Meanwhile, last November, the IRS put out proposed regulations to severely limit political activity by tax exempt, non-profit organizations. Abetted by the Supreme Court’s Citizens United decision, non-profit, tax exempt “social welfare” organizations spent $300 million on political activities in the 2012 elections. They can accept unlimited donations and do not have to disclose donors. They can run political ads, engage in other political activities, and make grants to other “social welfare” groups. Although the tax code says these organizations, known as 501(c)(4)s, cannot be engaged primarily in political activity, they easily got around this by claiming the ads and other activities were not political and had some kind of educational or civic purpose.

After ignoring this political activity for years, the IRS has now proposed excluding “candidate-related political activity” from the definition of social welfare activities. This would ban a wide range of political activities, unless they meet a strict nonpartisan test. Such regulations would be a huge step toward ending the huge amounts of “dark money” – where the source was hidden – that flowed into campaigns in 2012. These regulations on political activity should apply to any group, organized under any section of the IRS rules, that doesn’t have to disclose contributors, including business leagues (such as chambers of commerce) and unions. [3]

These reforms of our campaign finance system are a critical step in moving back toward the fundamental principle of one person, one vote. In the current system, it’s dollars that matter; 84% of the time the candidate with the most money won election to the House in 2012. Money also determines who runs and big donors drown out the voices of ordinary citizens in campaigns. In various ways, big donors buy election results.

The Supreme Court has ruled that the money of the wealthy and corporations cannot be limited or regulated, because it is speech. Therefore, we must amplify the voices of the rest of us (which the two bills in Congress will do) and require disclosure of all campaign contributions and spending. Otherwise, the integrity and legitimacy of our democracy is threatened, and people will justifiably conclude that the system is rigged and that their voices and interests are being drowned out by the money of wealthy individuals and corporations.

My next post will give examples of campaign spending that illustrate the need for reforms.


 

[1]       Hight, C., 2/6/14, “Government by the people, not the polluters,” The Huffington Post

[2]       Lioz, A., Feb. 2014, “The Government by the People Act,” Demos (http://www.demos.org/publication/government-people-act)

[3]       The Editorial Board, 2/18/14, “Change the rules on secret money,” The New York Times

REASONS FOR LACK OF PROSECUTIONS AFTER 2008 COLLAPSE

ABSTRACT: In Judge Rakoff’s article entitled “The Financial Crisis: Why have no high-level executives been prosecuted?” [1] he discusses the reasons given by officials of the Department of Justice (DOJ) for the failure to criminally prosecute either individuals or corporations.

Finding the publicly presented explanations for the failure to prosecute unconvincing, Rakoff then proposes some other reasons. First, he suggests that law enforcement agencies had other priorities and limited resources. Another possible explanation is the government’s own involvement in setting the stage for the 2008 financial crisis. The de-regulation of banks and the financial industry was a contributing factor. The federal government also had for years encouraged the growth of home ownership and the availability of mortgages, including to low income home buyers. It had also supported less stringent documentation and underwriting standards for obtaining a mortgage.

Finally, Rakoff notes a 30-year trend toward prosecuting corporations rather than prosecuting individuals. He states that the traditional approach was based on the fact that organizations do not commit crimes, only their human agents do. Rakoff believes that prosecuting individuals has a much stronger deterrence value than prosecuting corporations. He also believes that prosecuting just the corporation and not any individual is both legally and morally wrong.

FULL POST: In Judge Rakoff’s * article entitled “The Financial Crisis: Why have no high-level executives been prosecuted?” [2] (See previous post of 2/9/14 for more details:  http://lippittpolicyandpolitics.org/2014/02/09/too-little-punishment-for-misbehavior-in-the-financial-sector/), he discusses the reasons given by officials of the Department of Justice (DOJ) for the failure to criminally prosecute either individuals or corporations that were involved in causing the 2008 crisis. First, they argue that proving fraudulent intent is difficult. However, Rakoff points out that with clear evidence of mortgage fraud (e.g., numerous reports of suspected mortgage fraud from within the financial institutions themselves), executives couldn’t escape prosecution by claiming they didn’t know what was going on. Furthermore, convictions, despite claims ignorance, are well established in criminal law based on the doctrine that “willful blindness” or “conscious disregard” does not exonerate a defendant.

Second, Department of Justice (DOJ) officials sometimes argue that fraud couldn’t be proved because the buyers of the mortgage-backed securities were sophisticated investors who knew enough not to rely on any misrepresentations and deception by the sellers. Rakoff states that this “totally misstates the law.” The law says that if society or the market is harmed by the lies of a seller, criminal fraud has occurred.

Third, Attorney General Holder himself said in testimony to Congress that in considering a criminal prosecution the impact on the US and world economies had to be taken into consideration. This is called the “too big to jail” excuse. Holder has said that his comment was misconstrued. Rakoff notes that this rationale is irrelevant in terms of prosecuting individuals because no one believes that a large financial corporation would collapse if one or more of its high level executives was prosecuted.

Finding the publicly presented explanations for the failure to prosecute unconvincing, Rakoff then proposes some other reasons. First, he suggests that law enforcement agencies had other priorities and limited resources. He notes that in 2001 the FBI had over 1,000 agents assigned to investigating financial fraud. In 2007, there were only 120 agents working on financial fraud and they had more than 50,000 reports of possible mortgage fraud to review. The shift of agents to anti-terrorism after 9/11 and budget limitations are the two causes he cites for this reduced capacity to respond to financial fraud.

The Securities and Exchange Commission (SEC) has been focused on Ponzi schemes and misuse of customers’ funds. It too is experiencing significant budget limitations. The DOJ has been focused on insider trading cases. When the 2008 financial collapse occurred, it spread the investigation of financial fraud among numerous US Attorney’s Offices in various states, many of which had little or no previous experience with sophisticated financial fraud.

Another possible explanation of the failure to prosecute, according to Rakoff, is the government’s own involvement in setting the stage for the 2008 financial crisis. The de-regulation of banks and the financial industry, including the repeal of Glass-Steagall, was a contributing factor. Both the SEC and the Treasury Department had had their power and oversight weakened by de-regulation. The federal government also had for years encouraged the growth of home ownership and the availability of mortgages, including to low income (and therefore higher risk) home buyers. It had also supported less stringent documentation and underwriting standards for obtaining a mortgage. Hence, the federal government helped create the conditions that led to mortgage fraud and a corporate executive could, with some justification, claim in his defense that he believed he was only trying to further the government’s goals.

In addition, after the 2008 collapse, the government made little effort to hold the financial corporations accountable when it bailed them out.

Finally, Rakoff notes a 30-year trend toward prosecuting corporations rather than prosecuting individuals. He states that the traditional approach was based on the fact that organizations do not commit crimes, only their human agents do. In addition, prosecuting an organization inevitably punishes totally innocent employees and shareholders. However, in recent years “deferred prosecution agreements” and even “non-prosecution agreements” with corporations have become the standard fare. Under these, a corporation and its employees avoid prosecution by agreeing to take internal, preventive measures to protect against future wrongdoing, often while paying a fine.

Rakoff believes that prosecuting individuals has a much stronger deterrence value than the internal preventive measures of “deferred prosecution agreements” that are often little more than window dressing. He also believes that prosecuting just the corporation and not any individual is both legally and morally wrong. Under the law, a corporation should only be prosecuted if one can prove a managerial agent of the corporation committed the alleged crime. If so, why not prosecute that manager? Morally, punishing a corporation and many innocent employees and shareholders for crimes committed by an unprosecuted individual(s) seems unjust.

*    Jed Rakoff is a United States District Judge on senior status for the Southern District of New York. A full-time judge from 1996 to 2010, he moved to senior status in 2010. Senior status is a form of semi-retirement for judges over 65 where they continue to work part-time. Judge Rakoff is a leading authority on securities laws and the law of white collar crime, and has authored many articles on those topics. He is a former prosecutor with the U.S. Attorney’s office in New York. [3]


[1]       Rakoff, J.S., 1/9/14, “The Financial Crisis: Why have no high-level executives been prosecuted?” The New York Review of Books

[2]       Rakoff, J.S., 1/9/14, see above

[3]       Wikipedia, retrieved 2/5/14, “Jed S. Rakoff,” http://en.wikipedia.org/wiki/Jed_S._Rakoff

TOO LITTLE PUNISHMENT FOR MISBEHAVIOR IN THE FINANCIAL SECTOR

ABSTRACT: One person who has both spoken out and acted when he felt the punishment for misbehavior in the financial sector was too lenient or lacking is federal District Court Judge Jed Rakoff.* In 2011, he refused to approve a proposed settlement with Citigroup related to the 2008 financial crisis because he thought that it was too lenient. Currently, he is withholding approval of settlement of an insider trading case. The proposed settlement would allow two men to settle the case for $4.8 million without admitting guilt.

SAC Capital, a huge, $15 billion hedge fund, has been charged in what probably is the biggest insider trading scandal ever. Five employees of SAC have already pleaded guilty to insider trading and the company itself has agreed to a record $616 million settlement. However, it is unlikely that anyone will go to jail and the head of SAC, despite any fines and restitution he may be required to pay, is likely to remain a billionaire.

Judge Rakoff recently wrote an article entitled “The Financial Crisis: Why have no high-level executives been prosecuted?” [1] Multiple authorities, including enforcement agencies, have describe what occurred in the run up to the 2008 financial crisis as fraud. Rakoff states that if the financial crisis was the result of intentional fraud, then “the failure to [criminally] prosecute those responsible must be judged one of the most egregious failures of the criminal justice system in many years.”

Rakoff notes that in previous financial crises individual perpetrators were successfully prosecuted. In the 1980s savings and loan crisis, which has strong parallels to the 2008 crisis but at a much smaller scale, over 800 individuals were successfully, criminally prosecuted.

Rakoff concludes by writing, “if it was [fraudulent misconduct] – as various governmental authorities have asserted it was – then the failure of the government to bring to justice those responsible … bespeaks weaknesses in our prosecutorial system that need to be addressed.”

FULL POST: One person who has both spoken out and acted when he felt the punishment for misbehavior in the financial sector was too lenient or lacking is federal District Court Judge Jed Rakoff.* For example, in 2011, he refused to approve a proposed settlement by the Securities and Exchange Commission (SEC) with Citigroup related to the 2008 financial crisis because he thought that it was too lenient.

Currently, he is withholding approval of settlement of an insider trading case where two men, acting on an illegal insider’s tip, bought $90,000 worth of securities a day before the announcement of the buyout of H.J. Heinz (the ketchup maker). The next day, when the buyout was announced, the securities became worth $1.8 million. The SEC’s proposed settlement would allow the two men to settle the case for $4.8 million without either admitting or denying guilt. Such settlement language had been standard practice for insider trading cases until a public debate erupted, prompted in large part by Judge Rakoff. In June 2013, the new chair of the SEC, Mary Jo White, announced a new SEC policy that would require some defendants to admit guilt. [2]

There have been a number of insider trading cases in the news lately. These are cases where an individual buying or selling securities benefited from illegally obtained, confidential information that gave him or her an unfair opportunity to profit from securities transactions. For example, SAC Capital, a huge, $15 billion hedge fund, responsible for about 1% of all US securities exchanges’ average daily trading, has been charged in what probably is the biggest insider trading scandal ever. Five employees of SAC have already pleaded guilty to insider trading and the company itself has agreed to a record $616 million settlement for more than 10 years of trading based on illegal tips from corporate insiders. More legal action is still to come, but it is unlikely that anyone will go to jail and the head of SAC, Steven A. Cohen, despite any fines and restitution he may be required to pay, is likely to remain a billionaire. [3][4]

However, Judge Rakoff’s primary focus has not been on insider trading but on the financial industry’s misbehavior that led to the 2008 financial crisis and the Great Recession. He recently wrote an article entitled “The Financial Crisis: Why have no high-level executives been prosecuted?” [5] In it, he explores why there have been no criminal prosecutions when multiple authorities, including enforcement agencies, have describe what occurred in the run up to the 2008 financial crisis as fraud (i.e., intentional deception for financial or personal gain). Rakoff states that if the financial crisis was the result of intentional fraud (and he makes clear that he has no personal knowledge of whether that was the case or not), “the failure to [criminally] prosecute those responsible must be judged one of the most egregious failures of the criminal justice system in many years.”

Rakoff notes that in previous financial crises – the junk bond scandal of the 1970s, the savings and loan (S&L) crisis of the 1980s, and the accounting frauds of the 1990s (e.g., Enron and WorldCom) – individual perpetrators were successfully prosecuted. Specifically, in the S&L crisis, which has strong parallels to the 2008 crisis but at a much smaller scale, over 800 individuals were successfully, criminally prosecuted.

There is strong evidence of criminal fraud in the events leading to the 2008 crisis. The federal government’s Financial Crisis Inquiry Commission uses the word “fraud” 157 times in its report describing what led to the crisis. Furthermore, indications that fraud was occurring emerged well before the 2008 collapse. There were 20 times as many reports of suspected mortgage fraud in 2005 as in 1996, and the number kept growing. In 2008, the number of fraud reports was double that of 2005. As early as 2004, the FBI was publicly warning of the “pervasive problem” of mortgage fraud. In the years before the 2008 crisis, sub-prime mortgages, in other words mortgages with more risk of default than normal mortgages, increasingly provided the underpinnings for mortgage-backed securities that continued to be sold with AAA ratings. This rating is supposed to identify securities of very low risk. It seems impossible that this could have occurred without fraud taking place.

Rakoff discusses reasons given by officials of the Department of Justice (DOJ) for the failure to criminally prosecute either individuals or corporations and finds them unconvincing. He then proposes some reasons that he finds more believable. I’ll summarize all of this in my next post.

Rakoff concludes by writing, “if it was [fraudulent misconduct] – as various governmental authorities have asserted it was – then the failure of the government to bring to justice those responsible for such colossal fraud bespeaks weaknesses in our prosecutorial system that need to be addressed.”

*    Jed Rakoff is a United States District Judge on senior status for the Southern District of New York. A full-time judge from 1996 to 2010, he moved to senior status in 2010. Senior status is a form of semi-retirement for judges over 65 where they continue to work part-time. Judge Rakoff is a leading authority on securities laws and the law of white collar crime, and has authored many articles on those topics. He is a former prosecutor with the U.S. Attorney’s office in New York. [6]


 

[1]       Rakoff, J.S., 1/9/14, “The Financial Crisis: Why have no high-level executives been prosecuted?” The New York Review of Books (http://www.nybooks.com/articles/archives/2014/jan/09/financial-crisis-why-no-executive-prosecutions/?pagination=false)

[2]       Raymond, N., 1/30/14, “U.S. judge takes on SEC again, questions Heinz insider trading pact,” Reuters

[3]       Editorial, 7/27/13, “Pursuit of SAC Capital sends needed message to Wall St.,” The Boston Globe

[4]       Lattman, P., 7/31/13, “Ex-analyst charged in insider-trading crackdown,” The Boston Globe (from The New York Times)

[5]       Rakoff, J.S., 1/9/14, see above

[6]       Wikipedia, retrieved 2/5/14, “Jed S. Rakoff,” http://en.wikipedia.org/wiki/Jed_S._Rakoff

WEAK PENALTIES FOR FINANCIAL CORPORATIONS’ MISBEHAVIOR

ABSTRACT: If you follow the financial news, you regularly hear about financial corporations paying penalties as they reach settlements with regulators for their misbehavior. Although the amounts of some of the recent penalties have been noteworthy, keep in mind that to these large corporations they barely put a dent in their annual profits. Furthermore, in many cases the penalties are tax deductible as a business expense. This means that, in effect, the government and we as taxpayers are subsidizing the penalty by allowing the corporations to reduce their taxes by deducting the amount of the penalty from their income. In other cases, the corporations are allowed to take credit for having paid all or part of the settlement based on other actions they have taken.

This has led Senators Elizabeth Warren (MA Democrat) and Tom Coburn (OK Republican) to propose a Truth in Settlements bill in Congress that would require government regulators to disclose whether they are allowing all or part of the settlement amount to be deducted from income or paid with credits.

In most cases, the corporations are agreeing to the settlements without having to admit wrongdoing. There have been very few criminal charges against the corporations and none against any executive of any of the large financial corporations. Furthermore, the executives have continued to be lavishly rewarded despite behavior that plunged the world into a financial crisis and a recession.

If we are going to prevent another financial collapse and resulting recession, we must prevent serious misbehavior by our large financial corporations. Stronger laws, oversight, and enforcement, with stronger penalties for executives and corporations, including criminal prosecutions, are needed. These would provide the strong incentives necessary to ensure legal, ethical, and prudent behavior by executives and, hence, the corporations they run.

FULL POST: If you follow the financial news, you regularly hear about financial corporations paying penalties as they reach settlements with regulators for their misbehavior. Many of these settlements are for misbehavior that contributed to the 2008 financial collapse where enforcement actions are finally being concluded. Some are for more recent misbehavior. (See posts of 8/14/13, Large Financial Corporations Continue Illegal Activity [http://lippittpolicyandpolitics.org/2013/08/14/large-financial-corporations-continue-illegal-activity/] and 8/29/12, Big Financial Corporation Scandals Continue [http://lippittpolicyandpolitics.org/2012/08/29/big-financial-corporation-scandals-continue/] for more detail on financial corporations’ misbehavior.)

Although the amounts of some of the recent penalties – in the billions of dollars – have been noteworthy, keep in mind that to these large corporations this barely puts a dent in their annual profits. Their stocks have been performing well, despite the penalties. In many cases the penalties are tax deductible as a business expense, which means that the impact on the corporation is typically only two-thirds of the stated amount. As a result, in effect, the government and we as taxpayers are subsidizing the penalty by allowing the corporations to reduce their taxes by deducting the amount of the penalty from their income. In other cases, the corporations are allowed to take credit for having paid all or part of the settlement based on other actions they have taken. For example, in a 2013 settlement with 13 mortgage service providers for illegal foreclosures, over 60% of the announced $8.5 billion settlement could be paid through credits for modifications to existing mortgages.

This has led Senators Elizabeth Warren (MA Democrat) and Tom Coburn (OK Republican) to propose a Truth in Settlements bill in Congress that would require government regulators to disclose whether they are allowing all or part of the settlement amount to be deducted from income or paid with credits. The regulators would generally have to make settlement agreements public and for any that were kept confidential, they would have disclose that fact and their rationale for doing so. [1] Bills have also been filed to prohibit the deduction of penalties as a business expense.

In most cases, the corporations are agreeing to the settlements without having to admit wrongdoing. There have been very few criminal charges against the corporations. Most of the enforcement actions have been civil actions, which seriously limits the consequences, even if the corporation misbehaves again, even in a similar manner.

Also noteworthy, is that no executive of any of the large financial corporations has been charged with criminal activity. (My next post will explore this issue.) Furthermore, the executives have continued to be lavishly rewarded despite behavior that plunged the world into a financial crisis and a recession. A corporate culture of immunity for senior executives from the consequences of their actions appears to persist despite public outrage. [2]

For example, JPMorgan’s CEO, Jamie Dimon, will be paid $20 million for 2013. This is up substantially from the $11.5 million he was paid last year, despite the $20 billion in fines and penalties JPMorgan paid in 2013 (due to a variety of corporate misbehavior) and the very large related legal expenses. Apparently, JPMorgan’s Board of Directors feels Dimon did a great job of handling these matters with the regulators and that pay cuts in 2008 and 2012 had already punished him for having gotten the corporation into trouble in the first place. [3] The corporation’s stock did have a good year. It was up 37%, out pacing both its peers and the overall market. (Note: If JPMorgan’s Directors and shareholders feel the settlement agreements were so positive, maybe the regulators have let Dimon and JPMorgan off too lightly!) In 2008, Dimon received a $1 million salary and no bonus, presumably because of the problems that led to the financial crisis and the need for the government to bail out JPMorgan (among other financial industry corporations). However, by 2011 his compensation was up to $23 million. It was cut to $11.5 million for 2012, which was viewed as a strong rebuke by the corporation’s Board for the $6 billion loss on speculative trading that occurred in 2012.

Final figures for 2013 CEO compensation at two smaller financial corporations, Goldman Sachs and Morgan Stanley, were not available yet, but are expected to be above the 2012 levels that were $21 million and $9.75 million, respectively.

If we are going to prevent another financial collapse and resulting recession, we must prevent serious misbehavior by our large financial corporations. Stronger laws, oversight, and enforcement, with stronger penalties for executives and corporations, including criminal prosecutions, are needed. These would provide the strong incentives necessary to ensure legal, ethical, and prudent behavior by executives and, hence, the corporations they run.


 

[1]       Associated Press, 1/9/14, “Mass. Democrat: Settlements need more transparency,” in the Daily Times Chronicle

[2]       Stewart, J.B., 2/1/14, “Accounting for Dimon’s big jump in pay,” The New York Times

[3]       Silver-Greenberg, J., & Craig, S., 1/24/14, “Despite scandals, JPMorgan awards CEO raise,” The Boston Globe from The New York Times