If every American household lost $50,000 to an industry meltdown, you'd expect someone to go to jail. That's what a Dallas Federal Reserve Bank staff paper estimated the cost of the 2007-2009 Great Recession to be on U.S. consumers. While we can't say for sure who "caused" that recession, it's certain that the financial sector played a leading role. Five years on, there is still plenty of public resentment for the lack of visible enforcement actions dating back to the crisis. But lately, U.S. regulators have been flexing their muscles with a more pointed and aggressive approach to finding and punishing miscreants. This is enormously important for many reasons, but let's focus on the fact that restoring trust in financial markets depends more on enforcement of the existing rules than on the quality of the rules themselves.
There's plenty of cynicism surrounding the enforcement of securities laws. It's dismaying to note the numerous high-profile repeat offenders who either are unwilling or unable to keep their promises. In 2011, the New York Times found that 19 Wall Street giants were involved in at least 51 enforcement cases over the previous 15 years over securities laws they had previously agreed never to break again. Included in the count were some of America's largest financial firms, who have significant resources in the compliance and legal areas dedicated to client protection and internal compliance. The "Fabulous Fab" case against Fabrice Tourre this summer is the only moderately significant conviction of any individual for wrongdoing during the financial crisis in the US thus far.
We know that white collar crime is very difficult to prosecute. To compensate, U.S. officials have stepped up the use of surveillance techniques once used primarily for organized crime, and have been able to build much stronger cases against networks of insider trading leading to new cases against financial firms engaging in this behavior. Another way the SEC is flexing its muscles came with Mary Jo White's announcement in June that defendants will no longer be allowed to settle some cases with "neither admitting nor denying" wrongdoing. It remains to be seen whether this will force more cases into outright litigation, or whether, as J.P. Morgan did recently, they will proceed to settlement with language that is painful but not destructive to the firm's ability to do business. While the public looks for highly visible "perp walks," the sobering reality is that litigating against a major company is a war of attrition, costs a lot of taxpayer money and ties up resources for many years.
This more brawny approach to enforcement is a huge step in the right direction, but it needs to last in order to help restore investor confidence. The recent CFA Institute & Edelman Investor Trust Study showed that more than half of investors (52 percent) say regulators have the greatest opportunity to enhance trust by changing the industry -- far more than individual investment management professionals (28 percent) or investment management firms (13 percent). As long as two of our primary regulators, the SEC and the CFTC, are entirely dependent on Congressional budget allocations, despite the fact that they could be self-sustaining through industry fees, their sustainability is in doubt.
We are likely beyond the window of opportunity to re-write the regulatory books for financial services. That chapter finished with Dodd-Frank. Instead, it is critical that our capital markets be policed by well-funded, independent, courageous public servants. As the IMF has noted in a 2007 working paper, one of the most important ways to restore the public's trust in finance is by upholding the laws already on the books by pursuing, prosecuting and convicting those who engage in abuses and damage that trust. Financial services professionals must understand that their real value comes from a fiduciary framework of ethical business practices designed to serve the client. The global financial industry can be an extraordinary force for good by helping to solve economic and social problems. However, more work lies ahead to shape the industry into something better and we all need to start holding ourselves and each other to a higher standard.