05/21/2014 10:04 am ET Updated Jul 21, 2014

Too Big to Jail Decisions Hide Behind Closed Doors

For more than a decade, the Justice Department has increasingly relied on deals instead of courtrooms to address criminal corporate behavior. This record has been glaring with the large banks. And banking regulators are inevitably linked in this calculus.

In the weeks leading to the May 19 announcement of a guilty plea by Credit Suisse to one count of criminal conspiracy to aid tax evasion, US prosecutors consulted extensively with American bank regulators to ensure that the ramifications would not endanger the companies' operations. Explained Attorney General Eric Holder, "Because criminal charges involving a financial institution have the potential to trigger serious follow-on actions by regulatory agencies, this coordination was imperative. As the regulators have conveyed this afternoon, notwithstanding this plea agreement, the bank will move forward."

The bank will move forward?

The larger issue here is whether some financial institutions are "too big to jail." Holder himself raised this concern in congressional testimony when he confided that some institutions had become "so large" as to prevent full enforcement of the law. That comment followed questions about whether the Department of Justice (DOJ) pulled a punch with HSBC, which admitted to violating money laundering rules in the course of facilitating $200 trillion worth of transactions. The DOJ elected not to seek a criminal indictment.

Following the protest after the HSBC remark, Holder has attempted repeatedly to assure the public that justice is not size-based. On May 5, for example, Holder released a video where he publicly declared that those who believe the Department of Justice administers size-based justice with banks, that some financial institutions are "too big to jail" are "mistaken." Forthcoming prosecutions would prove his point, he concluded.

But the current prosecution of Credit Suisse raises questions about the role of decision-makers and their decision-making process. A circumstance where "the bank will move forward" does not perfectly accord with the assertion that no bank is "too big to jail." A guilty plea may be a reputational black mark for a large financial institution, but if regulators then stood on those judicial results to shutter the firms' businesses, then too-big-to-jail might truly be in question. If regulators instead agree they won't terminate licenses, as they did with Credit Suisse, then is too-big-to-jail really over?

The prosecutors' meetings with regulators were not public, but were nevertheless central to the application of justice at our large financial institutions. Though Holder has borne the brunt of public castigations in the HSBC case, in practice, the too-big-to-jail policy rests also on the shoulders of regulators and their supervisory discretion. No public official wants to be accountable for this policy, but bank regulators should not be able to hide behind closed doors.

Swiss-based Credit Suisse offers investment banking services in the United States. Legally, Credit Suisse's US operation is not a separate entity, but a branch of the Swiss parent. However, it is still subject to US and state laws. Its primary regulators are the New York State Department of Financial Services (DFS) led by Benjamin Lawsky; the Securities and Exchange Commission (SEC) led by Mary Jo White; and the New York Federal Reserve Bank (Fed), led by William Dudley.

In the Credit Suisse case, Lawsky established a monitor for the institution, named individuals that the bank must terminate, and exacted a fine of $715 million. But he concluded that "DFS has determined not to initiate proceedings to revoke Credit Suisse's New York license." He did not explain why he stopped short of reviewing the firm's license It is impossible to ignore that Credit Suisse's size figured in his decision.
Last week, the Securities and Exchange Commission voted to grant Credit Suisse a temporary exemption from a federal law that requires a bank to hand over its investment-adviser license in the event of a guilty plea, according to the New York Times. In a May 19 speech, Chair White insisted that her agency would not "cushion the blow of the criminal action taken or pave the way for a consequence-less guilty plea." She did not explain how Credit Suisse's size figured in the SEC's decision to allow the bank to keep its license.

The New York Fed fined Credit Suisse $100 million. The Fed's powers are broad as its statute provides that it can "take such other action as the banking agency determines to be appropriate." The Fed did not explain its decision to limit the penalty to a fine.

Some regulators have asserted that bank violations should carry repercussions, including SEC Commissioner Kara Stein. Waivers for penalties at the SEC have become common -- the norm, in fact, explained Commissioner Stein in her dissent in another case of bank wrongdoing: "Our website is replete with waiver after waiver for the largest financial institutions. Some large firms have received well over a dozen waivers of one sort or the other over the past several years. One large financial firm alone, in a 10 year period, has received over 22 different waivers." Denying a waiver for SEC penalties isn't the same harsh punishment that removal of a business license would be to Credit Suisse. But Stein's articulate dissent highlights that other regulators do bend the rules for large institutions.

The public deserves to know whether financial size figures into justice. Congress should mandate such disclosures, including making public the consultations between prosecutors, financial regulators and other experts. When prosecutors weigh size as a factor in meting out justice, they've effectively become financial architects by sustaining an industry dominated by giants. And, if banking regulators warn the Justice Department against exacting criminal sanctions owing to concerns about systemic contagion, or stop short with their own penalties, they've joined the prosecution dynamic and become part of the too big to jail problem.

As the nation recovers from the financial crash wrought by reckless banks infected with the moral hazard that they were too big to fail, the public deserves transparency into regulators' decision-making whether these institutions are also immune from justice. This means disclosing the meetings with bank regulators along with the basic content of consultations. Ideally, the law should be clear; where prosecutors and regulators exercise discretion, they should be willing to explain that discretion publicly.

In the end, where it becomes obvious that size shields enforcement, then giant banks should be broken down to a size where a criminal prosecution and license revocation become real threats, unlike today where they appear to be tools enforcers fear more than culprits.