After the 1929 stock market crash, Wall Street was perceived as being inadequately regulated. As a result of that perception, the administration of Franklin Delano Roosevelt created the Securities and Exchange Commission (S.E.C.). Its purpose was to protect Wall Street investors from the firms that handled their money.
The S.E.C. was created as an independent agency to be free from political control, but that is never entirely the case when Congress controls an agency's budget. The fear of increasing political control of the agency was the subject of an op ed article by Arthur Levitt, Jr. in the New York Times on August 7, 2011. Levitt, chairman of the S.E.C. from 1993 to 2001, pointed out there are bills pending that would micromanage the S.E.C. and that "we are witnessing a pattern of Congress grabbing the steering wheel of an independent agency."
The S.E.C. has been given huge new powers of regulation under landmark legislation passed in July 2010 known as Dodd-Frank, the result of the debacle on Wall Street involving banks and other financial institutions which caused losses in the trillions of dollars to investors. The era will always be joined at the hip with the phrase referring to many of those institutions as "too big to fail." I have done my best to add an additional phrase to the description, "too big to jail."
The New York Times and other media have covered the excesses of the financial institutions involved and the S.E.C.'s efforts to carry out its statutory obligation to pursue those institutions that have culpability generally as a result of fraud committed on investors. The S.E.C.'s authority is limited to civil fraud cases; if criminal fraud is alleged, the S.E.C. must turn the matter over to the Department of Justice for prosecution.
Many critics of the S.E.C. and the Department of Justice have pointed out that no CEO or CFO or members of a board of directors have been charged with criminal fraud for having abused the trust of their investors in the Great Recession. According to Edward Wyatt in the Times of November 30, 2011, when the S.E.C. has pursued a financial institution for civil fraud, as a matter of practice it allows the financial institution to "neither admit nor deny the commission's charges in return for a multimillion dollar fine and a promise not to do it again." The description was that of Judge Jed Rakoff, to whom a settlement entered into with Citigroup requiring a payment by the latter of $285 million was submitted, which he rejected.
The charge against Citigroup reported by Wyatt on November 29, 2011, was:
According to the Securities and Exchange Commission, Citigroup stuffed a $1 billion mortgage fund that it sold to investors in 2007 with securities that it believed would fail so that it could bet against its customers and profit when values declined. The fraud the agency said was in Citigroup's falsely telling investors that an independent party was choosing the portfolio's investments. Citigroup made $160 million from the deal and investors lost $700 million.
Some observers will ask why no restitution was required of Citigroup to protect the investors. The S.E.C. has no power to require restitution, so each investor must sue on his own to recover losses. Further, the S.E.C. is generally limited in its fining authority to the profit made by the securities firm, plus an additional amount for punitive damages.
All these fines go into the U.S. Treasury. The S.E.C. defended its decision to proceed this way -- an agreed settlement -- stating, "S.E.C. officials say they allow these kinds of settlements because it is far less costly than taking deep-pocketed Wall Street firms to court and risking the case," a reference by the S.E.C. to its lack of funding.
James B. Stewart of the Times reported on July 15th how the Congress, "the Republican-controlled Appropriations Committee" which "cut the Securities and Exchange Commission's fiscal 2012 budget request by $222.5 million to $1.19 billion (the same as this year's) even though the S.E.C.'s responsibilities were vastly expanded under the Dodd-Frank Wall Street Reform and Consumer Protection Act."
Stewart went on to point out the Congressional committee's comments on reducing the taxpayers' burden were a charade. The S.E.C.'s entire budget is funded totally by assessing the Wall Street firms. Stewart reported, "cutting the S.E.C.'s budget will have no effect on the budget deficit, won't save taxpayers a dime and could cost the Treasury millions in lost fees and penalties. That's because the S.E.C. isn't financed by tax revenue, but rather by fees levied on those it regulates, which include all the big securities firms."
Now to the ruling of Judge Rakoff, which has caused consternation on Wall Street. A New York Times editorial of November 29 summed it up:
Judge Jed Rakoff is furious. He should be. We all should be. On Monday, the Federal District Court judge rightly rejected a plan by the Securities and Exchange Commission to settle a securities fraud case against Citigroup, saying that the $285 million deal was 'neither fair, nor reasonable, nor adequate, nor in the public interest.' It's not only that the money was not enough, though it certainly seems puny compared with the damage done. The S.E.C. charged that Citigroup had not adequately disclosed to investors its role and interest in creating and selling -- and betting against -- a mortgage-backed investment that was intended to fail. When the investment did, indeed, tank, the bank made $160 million, according to the S.E.C., while investors lost $700 million.
The editorial continued:
It's not even that the S.E.C. only accused Citigroup of negligence, when Judge Rakoff said that his understanding of the matter indicates that a tougher charge of knowing or intentional fraud was probably warranted. Serious as all that is, Judge Rakoff's fundamental concern is that the S.E.C. did not provide any facts for the court to use to vet the settlement. Like most S.E.C. settlements with Wall Street firms, Citigroup was being allowed to settle without admitting or denying wrongdoing.
The S.E.C. and Citigroup will now have to decide whether to appeal or try the case. If another submission for settlement is made to the Judge, it is clear that Citigroup will have to admit guilt. If it admits guilt, it is possible -- I have not seen this discussed elsewhere -- that officers and others with direct responsibility for the alleged fraud could be personally pursued with respect to revoking their licenses to conduct business and perhaps even more.
The culprits here are not only the securities firms that committed fraud, civil or criminal, but the Congress that seeks to protect the industry from appropriate scrutiny by refusing to provide an adequate budget for the S.E.C. which would allow it to properly monitor the industry and sue violators. The Congress -- by its protection of the industry -- is losing fines that would go into the U.S. Treasury if those who brought the U.S. and its citizens to their knees economically by engaging in activities that violated the law were pursued by the S.E.C. Judge Rakoff is a light unto his fellow jurists. Let's hope they follow his lead.
The Chairman of the S.E.C., Mary L. Schapiro, wrote a letter on November 28th to Senator Jack Reed, chair of the Senate Subcommittee on Securities, Insurance and Investment, requesting changes in the law providing the S.E.C. with authority to impose greater monetary penalties for serious violations and for recidivists. Hopefully, her requests will be granted. Based on past performance, I doubt it. The House and Senate have been handmaidens for the Wall Street securities industry, seeking to protect them from any responsibility for the damages they have caused.
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