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:  https://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]