The SEC Nails a Minnow While the Whales Go Free
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The SEC Nails a Minnow While the Whales Go Free Why wasn't Goldman Sachs on trial alongside Fabrice Tourre?

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Last week, a jury in New York City convicted former Goldman Sachs trader Fabrice Tourre on six civil counts of securities fraud, for selling a toxic mortgage-backed bond to investors without disclosing that an architect of the deal, hedge fund Paulson & Co., also bet on its failure. This victory for the Securities and Exchange Commission signifies a long-awaited measure of justice for the unbridled greed and dirty dealing that sparked the financial crisis, but an exceedingly small one. Tourre was a young, mid-level employee (he was listed as a “vice president,” but so are hundreds of people at Goldman), not a decision-maker in executive suites throughout Wall Street. The conviction means he’ll pay a fine and probably get barred from the securities industry, an industry he’s already left to pursue a doctorate. This is hardly the level of accountability that practically the entire country demanded to see, especially when you consider that it represents the sum total of legitimate crisis-related convictions, and a non-criminal one at that.

“The SEC must stop chasing minnows while letting the whales of Wall Street go free,” noted Dennis Kelleher of the public interest group Better Markets.

Despite this, the Tourre case matters. It should lead Washington to rethink the conventional wisdom that financial regulators and Justice Department officials have spread about these cases: that they’re impossible to prosecute. It’s not just critical for how we remember the last crisis; it also shapes how we should think about the next one, whenever it comes to pass.

If you look at all the excuses for the total absence of prosecutions of major bank executives for their roles in nearly crashing the global economy, you find two major themes. First, the financial industry’s conduct was perhaps unethical but not technically illegal, especially since the peculiarities of securities law ensure that well-heeled bank executives will find some loophole to exculpate themselves from guilt. Second, juries will not be able to understand the hopelessly complex intricacies of the law, and will simply punt before agreeing beyond a reasonable doubt on the guilt of the bankers.

The Tourre case proves these both wrong. “To say [the case] discredits a silly argument gives that argument too much weight,” said Neil Barofsky, former Special Inspector General of TARP and a frequent critic of the lack of fraud prosecutions. He pointed to the numerous convictions of accounting fraud in the Enron and WorldCom era, in cases that were at least as complex as the 2008 crisis. “Ultimately fraud is fraud,” Barofsky said. “Complex issues may surround the case, but juries are more sophisticated than people give them credit for. They take their job seriously.”

That appears to be the result of the trial of Fabrice Tourre. The jury, which has been interviewed extensively, fully understood that Tourre was something of a scapegoat and not the central decision-maker at the firm. They recognized that senior executives at Goldman Sachs approved the deal, known as Abacus. And they generally discounted the damning emails from Tourre, who nicknamed himself “Fabulous Fab,” bragging about selling the toxic bonds to “widows and orphans.”

Instead, they bore down into the details, asking simple questions about whether Tourre’s lack of disclosure to investors about the designed-to-fail quality of Abacus represented securities fraud. They saw through the allegation that the industry generally did not disclose the participation of hedge funds like Paulson in derivatives deals, and focused on whether that constituted a material misrepresentation. And Tourre’s participation in the scheme, not his place on the totem pole at Goldman, was the determinative factor. The Rev. Beth Glover, a juror and a priest, summed it up: “They portrayed him as a cog, but in the end a machine is made up of cogs and he was a willing part of that.” While Toure faced civil charges with a lower burden of proof, these core insights from the jury could have been employed even in criminal financial fraud cases.

The media widely expected the jury to get bored or confused, or dismiss laying down the hammer of the law on a junior employee, and deliver a not guilty verdict. The defense must have agreed, given that they didn’t call a single witness in the case (Tourre did testify, but was called by the SEC). Everyone underestimated the jury as much as the Justice Department underestimated their authorities in the aftermath of the crisis. The truth is that there was lots of prosecutable conduct here, and the jury saw through the smokescreens and found the fraud. Replicate this dynamic for everyone involved in deals like this, which were ubiquitous on Wall Street, and you’d have enough guilty traders to fill several high-rises.

That doesn’t mean that the Justice Department would have won every financial fraud case they filed. In fact, they still seem haunted by the one they lost, a criminal trial against two hedge fund traders at Bear Stearns in 2009. The hastily chosen case relied on internal emails that prosecutors only presented in part, allowing the defense to bring out additional context, which put the traders in a better light. Justice has clearly been gun-shy ever since; they have confined their financial fraud prosecutions to easier-to-prove insider trading schemes, or instances where lowly individuals defrauded banks, rather than the instances where banks defrauded customers. Where banks have been found culpable, they have paid their way out through settlements, usually not having to admit wrongdoing.

“This is the most basic thing, you win some and you lose some,” said Neil Barofsky. “If you lose one and declare you will lose them all, you will have no significant cases.” And the truth is that there were significant cases to be made against executives. At the very least, Justice could have tried to flip people like Fab Tourre, to get at their bosses. This is how you would treat any criminal syndicate, which certainly resembles Wall Street circa 2008. “These cases do have complexity, and prosecuting wealthy and powerful Wall Street bankers is a lot to chew off,” said Brandon Rees of the AFL-CIO’s Office of Investment. “But it’s vital to changing the way Wall Street operates.”

I should note here that this is largely a theoretical argument now. With the last of these dodgy deals occurring in 2007, the statute of limitations for prosecutions has largely expired. The vaunted Financial Fraud Enforcement Task Force, reinvigorated when New York Attorney General Eric Schneiderman was named to a working group to investigate mortgage securities fraud, has yielded not one criminal subpoena and few civil cases. In fact, the executive director of the task force, Michael Bresnick, abruptly resigned last week, giving one day’s notice, to become a partner at a DC law firm specializing in “white collar criminal defense.”

Without vigorous efforts, including criminal charges, to hold Wall Street firms accountable, you get an industry that predictably pursues exactly the same kinds of behavior with relative impunity. The risk-chasing structure of the financial system continues to encourage and even incentivize fraud, especially given the lack of punishment.

However, there’s a chance we can look back on the Fab Tourre saga as a turning point, not for this past crisis, but for the next one. Somewhere along the line, we’re going to have another mass crime wave on Wall Street, if it’s not happening already. And it will be good at that point for regulators like the SEC to believe that they can try a case and win. Under new Chairwoman and former federal prosecutor Mary Jo White, the SEC has rejected “neither admit nor deny settlements” where the subject doesn’t have to agree that they committed wrongdoing. The Tourre case “should embolden the SEC not to worry about complexity,” said Neil Barofsky. “It gives them more credibility with their new policy and a bit more confidence that they can pull it off.”

We don’t have a legal system that is incapable of holding banks accountable. Until now, we’ve had a regulatory and political system with a complete lack of will to carry things through. Maybe the conviction of Fabulous Fab will begin to change that.

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