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Ronald J. Strauss Headshot

'Moral Moral Hazard,' the SEC and the Restoration of Wall Street Values

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The SEC recently announced its intention to abandon the long-standing practice of settling enforcement actions that allow defendants to avoid either admitting or denying guilt. The new settlement model would require admission of guilt for those egregious cases where the misconduct caused significant harm to investors and the financial markets. As SEC Chair Mary Jo White noted, "public accountability in particular kinds of cases can be quite important." We say its about time and applaud this landmark policy change.

It has become routine in financial industry settlements to include a "no fault" clause even when they are caught red-handed. For example, the $550 million settlement entered into by Goldman Sachs in the infamous Abacus deal -- the largest financial industry settlement at the time -- failed to include any admission of guilt.

While the current model facilitates settlements and avoids lengthy legal proceedings, it muddles the distinction between right and wrong and creates what we term "moral moral hazard" and systemic risk in our financial system. (The duplication of the word moral is intentional.) Financial penalties, even those running into the hundreds of millions, have become a cost of doing business for Wall Street. By requiring banks to admit guilt, the SEC can help to bring much needed moral accountability to the financial industry and in the process help to reduce systemic financial risk.

This SEC's revised approach reflects widespread public exasperation that the government has been unable to hold Wall Street accountable for its role in the financial crisis. Judges too have become increasingly hesitant to approve high-profile settlements without an admission of guilt. In rejecting proposed $285 million settlement with Citicorp, Federal District Court Judge Jed Rakoff, asked: "Why should the court impose a judgment in a case in which the SEC alleges a serious securities fraud, but the defendant neither admits nor denies wrongdoing?"

Huge settlements with no admission of guilt make the SEC complicit in fostering what we term "moral moral hazard" which in turn increases systemic financial risk. The $550 million fine paid by Goldman was the largest ever paid for securities fraud. It was, however, essentially, hush money and the magnitude of the fine did not help establish any principles of responsibility. Not surprisingly, the huge settlement resulted in no significant changes in Goldman Sachs business practices. Indeed the settlement allowed former Chair Lloyd Blankfein to maintain its Orwellian illusion that firm had done nothing wrong.

There is simply no way to sugarcoat that the fact that unethical behavior on Wall Street can reap huge profits for firms and individuals. A big reason behind the continuing mentality of denial with respect to questions of ethics on Wall Street is quite simply that Wall Street has been able to buy off any finding of culpability. The government has relied on checkbook justice and Wall Street has been able to write off seemingly huge settlements as a mildly irritating cost of doing business.

We fully support the SEC's change of heart as a vital step towards regaining moral high ground with respect to our financial system. It has been nearly five years since the financial and moral crisis of 2008 and still we have not learned its most important lessons. Moral values and sound business ethics are the lynchpins of healthy financial markets. Settling cases without moral clarity compromises fundamental principles of accountability and increases the "moral moral hazard" that corrodes our financial system. The SEC should use its legal powers to motivate Wall Street firms to reexamine and reinvent their values and business ethics in order to bring the financial industry into greater alignment with the public interest. As former SEC Chair Richard Breeden famously said over two decades ago, "it is not an adequate ethical standard to aspire to get through the day without being indicted."

Michael A. Santoro is a Professor at Rutgers Business School. Ronald J. Strauss is an Assistant Professor at the School of Business of Montclair State University. They are co-founders of wallstreetvalues.org and co-authors of Wall Street Values: Business Ethics and the Global Financial Crisis (Cambridge 2013).