Long silent and now contradictory, President Obama needs to deliver a clarifying speech about our financial markets and the rule of law. Speaking in Kansas on December 6, he said, "Too often, we've seen Wall Street firms violating major anti-fraud laws because the penalties are too weak and there's no price for being a repeat offender." Just five days later on 60 Minutes, he said, "Some of the least ethical behavior on Wall Street wasn't illegal." Which is it? Have there been no prosecutions because Wall Street acted legally (albeit unethically)? Or did Wall Street repeatedly violate major anti-fraud laws (and should thus find itself in the dock)?
The President is confusing "legal" with "difficult to prosecute successfully." The Justice Department's repeated decisions not to risk losing at trial against Wall Street executives don't make these person's actions legal. (If a district attorney can't prove the actual thief stole your wallet, that doesn't make stealing legal. It simply means that, regrettably, a malefactor goes unpunished.) As Securities and Exchange Commission Enforcement Director Robert Khuzami said in Senate testimony in 2009, Wall Street perpetrators "are smart people who understand that they are crossing the line" and "are plotting their defense at the same time they're committing their crime."
Moreover, the President is misleading us when he says that Wall Street firms violate anti-fraud law because the penalties are too weak. Repeat financial fraudsters don't pay relatively paltry -- and therefore painless -- penalties because of statutory caps on such penalties. Rather, regulatory officials, appointed by Obama, negotiated these comparatively trifling fines. This week, the F.D.I.C. settled a suit against Washington Mutual officials for just $64 million, an amount that will be covered mostly by insurance policies WaMu took out on behalf of executives, who themselves will pay just $400,000. And recently a federal judge rejected the S.E.C.'s latest settlement with Citigroup, an action even the Wall Street Journal called "a rebuke of the cozy relationship between regulators and the regulated that too often leaves justice as an orphan."
The Obama Justice Department hasn't tried a single Wall Street executive in a criminal court. Against a handful, it decided to let the S.E.C. bring civil charges of fraud, which are easier to prove. So if defendants' wrists are merely being slapped by the S.E.C. instead of cuffed by the Justice Department, Obama has only his appointees to blame.
For three important reasons, the President needs to explain why the Justice Department has filed away its investigations of big banks and Wall Street firms without indicting anyone. First, American confidence in the system is deeply shaken. Second, it strains credulity for millions of Americans -- and has impelled thousands of them to occupy public places in protest -- that no banking or insurance executive deserves criminal prosecution for the actions that brought on the financial crisis. Third, by failing to prosecute a single high-profile Wall Street actor today, the Administration is failing to deter financial fraud tomorrow.
The jury is out (alas, only metaphorically) on whether Wall Street practices that accompanied the financial crisis amounted to criminal fraud. Some legal commentators have concluded that the causes of the crisis were systemic and not the result of malfeasance or conspiracy. The debate about whether practices were illegal or simply unethical will never be resolved because only a jury can render a verdict after weighing the evidence, presented by opposing counsel, for each element of an alleged crime. That said, independent fact-finders like the Financial Crisis Inquiry Commission, the Senate Permanent Committee on Investigations, and the bankruptcy examiner for Lehman Brothers have compiled compelling evidence of what, to many, certainly looks like fraud.
But did the Justice Department's senior leadership even make targeting high-level fraud a top priority? Did it plan, staff, fund, and direct a thorough, probing investigation of each of the primary potential defendants? While I was working in the Senate, conversations I had with Justice Department officials led me to believe that it didn't. As the New York Times and New Yorker have reported, the Department's leadership never organized or supported strike-force teams of bank regulators, F.B.I. agents, and federal prosecutors for each of the potential primary defendants and ignored past lessons about how to crack financial fraud. When Senator Ted Kaufman (D-DE) and I met privately with Department officials in September 2009, one of them explained they were dependent on investigators to bring them cases (which typified, I believed, their passive approach). And, for their part, the investigators were receiving no help from bank regulatory agencies (in the 1990s, successful prosecutions after the savings-and-loan scandal hinged on referrals from the responsible supervising agencies, which provided key roadmaps for F.B.I. investigations).
The Justice Department, F.B.I., and bank regulatory agencies failed to design a prosecutorial strategy that would've indicted and perhaps convicted many top executives who knew that their banks were selling fraudulent securities that bundled together thousands of largely bad loans. These loans, known in the industry as stated-income loans and (more glibly and more accurately) as liar loans, were issued without verifying the borrowers' income. A former executive in charge of fraud investigations at mortgage lender Countrywide Financial told 60 Minutes that mortgage fraud at her firm was "systemic," but federal investigators never contacted her. The U.S. attorney in Los Angeles has already declined to prosecute Countrywide executives. The Senate's Permanent Subcommittee on Investigations found that approximately 90 percent of WaMu's home-equity loans were stated-income loans, creating, in the words of Treasury Department Inspector General Eric Thorson, a "target rich environment for fraud." Yet the U.S. Attorney in Seattle decided not to indict anyone at WaMu.
Failure to disclose material information is another form of potential fraud. Merrill Lynch, for example, understated its risky mortgage holdings by hundreds of billions of dollars. Executives at Lehman Brothers assured investors in the summer of 2008 that the company was sound, even though the bankruptcy examiner later concluded that Lehman had engaged in "actionable balance-sheet manipulation."
Yes, with financial fraud, criminal intent is difficult to prove, especially when a defendant relied on professional advice from accountants and lawyers (and in some cases may even have been acting with the knowledge of the bank's regulator, who was apparently more concerned about the bank's financial soundness than about full disclosure to investors). But we shouldn't outsource the interpretation of fraud laws to a potential defendant's accountant and lawyers. And why haven't prosecutors used provisions in the Sarbanes-Oxley Act, which put in place tough criminal sanctions in the wake of Enron and other cases of massive corporate frauds? In the absence of an aggressive, targeted effort by the Justice Department, we'll never know whether crimes may have been proved beyond a reasonable doubt.
Why didn't this happen? I wish I knew. At the Senate oversight hearings, Justice Department officials assured the Judiciary Committee that every lead was being pursued and every rock turned over. Doubtless they'll continue to claim this. Yet in Ron Suskind's book, Confidence Men, he quotes Treasury Secretary Timothy Geithner as saying, "The confidence in the system is so fragile still... a disclosure of a fraud... could result in a run, just like Lehman." The Obama Administration is pushing hard for a 50-state settlement with the major banks for their fraudulent foreclosure practices, even though several state attorneys general have rejected this approach because, in their view, it would shield too much wrongdoing. Regrettably, Obama's top officials and lawyers seem more eager to restore the financial sector to health than establish criminal accountability among the executives who were in charge.
In 1986, speaking about the failure of another president's Justice Department to vigorously prosecute white-collar crime, former Chairman of the Senate Judiciary Committee and current Vice President Joseph Biden said that "people believe that our system of law and those who manage it have failed, and may not even have tried, to deal effectively with unethical and possibly illegal misconduct in high places." Until this president stops calling Wall Street's deleterious actions "not illegal," he's failing to deter -- and therefore effectively encouraging -- future financial fraud. And until he gives a clear and full explanation of the inadequate response of his Justice Department and S.E.C., he and his appointees are helping to undermine the public's faith in equal justice under the law.
Jeff Connaughton is the former chief of staff to former U.S. Senator Ted Kaufman (D-DE), who chaired two Senate Judiciary Committee oversight hearings on financial fraud prosecutions in 2009 and 2010.