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A N 8 8 D 8 B 1 AR SINCE WWW. NYLJ.COM VOLUME 250—NO. 46 WEDNESDAY, SEPTEMBER 4, 2013

WHITE-COLLAR CRIME Expert Analysis Why So Few Prosecutions Connected to the Financial Crisis?

n a recent interview, Attorney General investigations and prosecutions of account- Eric Holder told The Wall Street Journal ing fraud and misstatements in financial that he expects to announce in the com- statements. These investigations and pros- ing months significant cases arising from ecutions led to high-profile convictions of the financial crisis of 2008.1 The Attor- officials at Enron, WorldCom, Adelphia and Iney General’s remarks follow criticism that many other companies. the administration has not done enough to By And The contrast between these two periods prosecute individuals and institutions said Elkan Jonathan is reflected in the work of the financial fraud to be responsible for the crisis. One com- Abramowitz Sack taskforces created by the administrations mentator, noting that the Attorney General of George W. Bush and Barack Obama. In did not say whether the new cases would ed, broadly speaking, to the financial this article, we compare the work of the be civil or criminal, dismissed the prospect crisis, but ultimately skirted its edges. In two taskforces and then consider some of new cases with the quip, “I’ll believe it one case, against hedge fund managers possible reasons for the relative dearth of when I see it.”2 of Bear Stearns, the charges stemmed high-profile criminal cases arising from the In fact, the Department of Justice has from statements to investors about their financial crisis. brought few, if any, high-profile criminal funds’ mortgage-related investments, An Overview cases since 2008 charging important figures but the prosecution did not challenge in the mortgage and financial industries, or the underlying issuance or sale of the In November 2009, President Obama otherwise addressing in criminal charges financial instruments.6 In other cases, the announced the creation of a joint fed- the financial transactions that contrib- charges stemmed from inflated valuations eral and state taskforce, the Financial uted to the crisis. We have seen charges of mortgage-related securities.7 Fraud Enforcement Taskforce, to combat against Ponzi schemers exposed by the The high-profile criminal cases of the past financial fraud. The FFETF replaced the sharp decline in securities prices in 2008 several years, involving insider trading and Corporate Fraud Taskforce created by to 2009,3 and a slew of charges involving Bank Secrecy Act and money laundering vio- President Bush in July 2002 in response relatively low-level mortgage frauds,4 but lations, bear little or no relation to the finan- to the bursting of the tech bubble and a the criminal cases brought by the depart- cial crisis.8 These cases have held prominent spate of reported false and misleading ment are widely seen as missing the heart individuals and companies accountable for financial statements by public companies. of what caused the financial crisis.5 serious wrongdoing, but even then, have not Although the stated mission of both task- In several instances, the department satisfied the critics who complain that the forces is almost identical—to strengthen has brought criminal charges that relat- institutions have gotten off too lightly, and the investigation and prosecution of “sig- that the company officers and employees nificant financial crimes” and “ensure the involved in the illegal conduct were wrongly just and effective punishment of those given passes.9 who perpetrate” those crimes10—the work ELKAN ABRAMOWITZ and JONATHAN SACK are members of Morvillo Abramowitz Grand Iason & Anello. Abramowitz is The disparity between perceived finan- of the two taskforces looks very different. a former chief of the criminal division in the U.S. Attorney’s cial misdeeds and criminal prosecutions While the Bush taskforce released regular Office for the Southern District of New York. Sack is a former contrasts sharply with the period, about reports to the president and the public with chief of the criminal division in the U.S. Attorney’s Office for the Eastern District of New York. GRETCHAN R. OHLIG, 10 years ago, when prosecutors and defense detailed information, the FFETF has issued an attorney, assisted in the preparation of this article. lawyers were heavily engaged in criminal only one report in almost four years, and the WEDNESDAY, SEPTEMBER 4, 2013

information was vague. In addition to the On the civil side, the work of the Resi- officers, and obtained over $2.2 billion in infrequent reporting, the type of work done dential Mortgage-Backed Securities Working monetary relief.17 by each taskforce differs as well. The Bush Group, established after the release of the A similar upward trend has been doc- taskforce took credit for thousands of crimi- FFETF’s first year report and cochaired by umented at the CFTC. Fiscal year 2011 nal convictions, boasting in its 2008 Corpo- New York Attorney General Eric Schneider- brought record highs with 99 enforcement rate Fraud Taskforce Report to the President man, is illustrative. Schneiderman brought actions, the highest tally in the agency’s his- of nearly 1,300 corporate fraud convictions, the working group’s first case in October tory and a 74 percent increase over the prior including the conviction of almost 400 CEOs, 2012, filing a Martin Act lawsuit against year, and more than 450 new investigations CFOs, corporate presidents and vice presi- JPMorgan Chase Bank alleging fraud in the opened. In fiscal year 2012, the agency filed dents.11 These prosecutions included the package and selling of residential mortgage- 102 enforcement actions and opened 350 Justice Department’s Enron-related prosecu- backed securities.14 new investigations.18 tions, the Computer Associates securities Why So Few? fraud prosecution in the Eastern District of New York, and options backdating and tax The high-profile criminal cases Several explanations have been offered shelter prosecutions in the Southern District of the past several years bear for the relative dearth of crisis-era criminal of New York, to name a few. cases. We venture some preliminary conclu- This administration’s taskforce, on the little or no relation to the fi- sions of our own. other hand, has talked primarily of civil nancial crisis. First, the financial instruments and cases and regulatory enforcement actions. transactions underlying the recent crisis To the extent the FFETF has made refer- In addition, agencies that belong to the are immensely complex and involve many ence to criminal cases, it is not clear FFETF have relied heavily on civil stat- individuals performing highly technical whether and how they relate to the finan- utes to pursue wrongdoing. In the most tasks with large volumes of data. These cir- cial crisis. The single report released by recent example, Attorney General Holder cumstances present substantial challenges the FFETF in 2011, documenting its first announced a suit against Bank of America to prosecutors not only in understanding year accomplishments, contained no sum- under the Financial Institutions Reform, the relevant facts, but also in explaining mary statistics and did not separately Recovery, and Enforcement Act of 1989 the transactions to a jury. In fact, labor in identify criminal and civil enforcement (FIRREA), alleging fraud in connection many financial transactions is so divided efforts.12 Rather, the report listed the with the sale of over $850 million of resi- among different individuals that any one enforcement groups established within dential mortgage-backed securities, as individual’s guilt can be quite difficult to the taskforce and significant enforcement part of the ongoing efforts of the FFETF.15 articulate, much less prove beyond a rea- actions in each of those areas. Criticized Earlier this year, the taskforce announced sonable doubt. for its slow start,13 the FFETF appears to a lawsuit filed against Golden First Mort- In this light, the Justice Department’s reli- be largely a clearinghouse of information gage and its owner and president under ance on theories of civil liability and lower and resources to facilitate enforcement the FIRREA and the False Claims Act, burdens of proof in cases involving complex by other government agencies. another civil statute frequently relied on mortgage-related financial products makes a While the First Year Report provided by the federal government in pursuing lot of sense from a strategic standpoint, even some data on criminal cases, informa- financial fraud.16 if it leaves some critics unhappy. The Depart- tion on civil enforcement cases seemed Although the FFETF has not released ment has turned to FIRREA and the FCA to to predominate. On the criminal side, the new statistics since 2011, those released file civil charges against financial institutions Mortgage Fraud Working Group noted by member agencies of the taskforce for false statements and fraud in connection an increase in the number of defendants confirm that the government is pursuing with the complex financial deals underly- charged with mortgage fraud by U.S. Attor- more civil remedies in response to the ing the financial crisis. The department has ney Offices and a corresponding increase 2008 financial crisis. Enforcement statis- likewise charged entire firms rather than in the severity of sentences imposed in tics from the SEC reveal a constant steady individuals, no doubt because of the great those cases. The Securities and Commodi- uptick in enforcement actions. Fiscal years difficulty showing sufficient participation ties Fraud Working Group, cochaired by 2011 and 2012 brought the highest num- and knowledge by any one individual to Preet Bharara, the U.S. Attorney for the bers ever for the agency, with 735 and 734 warrant criminal sanction.19 Southern District of New York, reported total actions in those respective years. In Second, the very depth and breadth that in fiscal year 2010, more than 95 per- the SEC’s 2012 annual report, Chairwoman of the recent financial crisis makes it dif- cent of the Commodity Futures Trading Mary Schapiro noted that in connection ficult to separate criminal behavior from Commission’s major injunctive fraud cases with the financial crisis, the SEC has filed business misjudgment and mistake. That related to criminal investigations and that actions against 117 entities and individu- situation in which virtually all financial at least 65 percent of those cases resulted als (in 80 actions) including more than 50 institutions were buying, selling and hold- in criminal charges. CEOs, CFOs and other senior corporate ing, in varying degrees, the same type WEDNESDAY, SEPTEMBER 4, 2013

20 of products, and virtually all such insti- District of New York and revisions to the ••••••••••••••••••••••••••••• tutions suffered losses, the government department’s policies toward what would 1. Devlin Barrett, “Justice Department Plans New Crisis- Related Cases,” The Wall Street Journal (Aug. 20, 2013). naturally finds it difficult to show that a be required of companies seeking to avoid 2. Solomon L. Wisenberg, “Financial Meltdown Prosecu- particular individual had a criminal state prosecution.21 tions Against Elite Actors? File Them Under ‘I’ll Believe It When I See It,’” White Collar Crime Prof Blog (Aug. 22, 2013). of mind. In the months leading up to the In short, following the financial crisis the 3. See, e.g., Justice Department Website, “United States v. Bernard L. Madoff and Related Cases” (available at: http:// collapse of the housing market in 2007, government has not been given the same www.justice.gov/usao/nys/vw_cases/madoff.html). market participants (and government head start in figuring out what happened and 4. See, e.g., Press Release, FFETF, “Former Officers of American Mortgage Specialists Inc. Sentenced for $28 Mil- officials) had certain beliefs and made a road map of evidence to prove who was lion Fraud Against BNC National Bank” (June 28, 2013). certain predictions, typically based on culpable. Because of the structure of large 5. See Elkan Abramowitz and Jonathan Sack, “The ‘Civil- izing’ of White Collar Criminal Enforcement,” NYLJ (May 7, past behavior, of what would happen institutions, the government faces inherent 2013); John C. Coffee, Jr., “Securities Enforcement: 2013 Re- port Card,” NYLJ (May 16, 2013). in the future. Most of these beliefs and hurdles in proving that high-level officers 6. Zachery Kouwe and Dan Slater, “2 Bear Stearns Fund predictions turned out to be wrong, but of a company had the requisite knowledge Leaders Are Acquitted,” The New York Times (Nov. 10, 2009). 7. See Press Release, U.S. Attorney’s Office Eastern Dis- when entire industries and government and intent to commit a financial crime. The trict of New York, “Jury Finds Former Credit Suisse Broker Guilty of Securities Fraud” (Aug. 17, 2009). agencies are wrong, it is difficult for pros- lack of substantial assistance from thorough 8. See, e.g., Press Release, U.S. Attorney’s Office for the ecutors to show that one person, or even internal investigations, combined with the Eastern District of New York, “HSBC Holdings Plc. and HSBC Bank USA N.A. Admit to Anti-Money Laundering and Sanc- institution, knew the truth and chose to complex circumstances giving rise to the tions Violations, Forfeit $1.256 Billion in Deferred Pros- hide or distort it. financial crisis, has substantially increased ecution Agreement” (Dec. 11, 2012); Press Release, FFETF, “Hedge Fund Founder Raj Rajaratnam Sentenced in Manhat- In contrast, when the government aggres- the difficulties of charging high-level officials tan Federal Court to 11 Years in Prison for Insider Trading Crimes” (Oct. 13, 2011). sively pursued accounting fraud cases fol- with criminal wrongdoing. 9. See Elkan Abramowitz and Jonathan Sack, “Why So Few lowing the tech bubble, the relevant facts Individuals? Government’s Prosecution of Corporate Mis- conduct,” NYLJ (March 5, 2013); Evan Weinberger, “Warren were largely company-specific; forensic Wants More Info on $225M FHA Settlement,” Law360.com accountants could come in after the fact (Aug. 21, 2013). The Justice Department’s re- 10. See Corporate Fraud Taskforce, Report to the Presi- and show the inflated revenue, disguised dent, “Message from the Chairman” (2008); Press Release, liance on theories of civil li- U.S. Securities and Exchange Commission, “President expenses, and hidden liabilities; and often Obama Establishes Interagency Financial Fraud Enforce- subsequent restatements by the company ment Taskforce” (Nov. 17, 2009). ability and lower burdens of 11. Corporate Fraud Taskforce, “Report to the President” (commonly, by new management) provided at p. iii (2008). proof in cases involving com- 12. Financial Fraud Enforcement Taskforce, “First Year Re- a clear road map of how prior financial state- port” (available at: http://www.stopfraud.gov/docs/FFETF- ments were wrong. plex mortgage-related finan- Report-LR.pdf). 13. See Evan Weinberger, “Obama’s MBS Taskforce Primed Third, since the last wave of financial cial products makes a lot of for Fights with Big Banks,” Law360 (Aug. 9, 2013); Associated fraud cases following the tech bubble, we Press, “US Gov. Sues BofA Over Mortgage Bond Sale” (Aug. sense from a strategic stand- 6, 2013). have arguably witnessed substantial 14. Press Release, FFETF, “Residential Mortgage-Backed point, even if it leaves some Securities Working Group Members Announce First Legal Ac- changes in the way companies and pros- tion” (Oct. 2, 2012). See also Press Release, FFETF, “Residen- ecutors deal with one another during an critics unhappy. tial Mortgage-Backed Securities Working Group Members Announce Charges Against Credit Suisse” (Nov. 20, 2012). investigation. Above all, the recent finan- 15. Press Release, Department of Justice, “Depart- cial crisis seems to have generated sub- ment of Justice Sues Bank of America for Defrauding Conclusion Investors in Connection with Sale of Over $850 Mil- stantially fewer long and searching inter- lion of Residential Mortgage-Backed Securities” (Aug. 6, 2013). nal investigations than did the accounting The new crisis-era cases promised by 16. Press Release, FFETF, “Golden First Mortgage Corp. Attorney General Holder will no doubt tell and David Movtady Named in Mortgage Fraud Lawsuit for scandals of the early 2000s—perhaps Fraudulently Certified Loans” (April 4, 2013). because, when the survival of institu- us something important. They may show us 17. U.S. Securities and Exchange Commission, Fiscal Year 2012 Agency Financial Report (available at: https://www.sec. tions was in doubt, few saw the need or that the crisis can give rise to criminal pros- gov/about/secafr2012.shtml). ability to conduct such investigations— ecutions of high-level individuals, or they may 18. Commodity Futures Trading Commission, Agency Financial Report, Fiscal Years 2011 and 2012 (available at: and when those investigations took place reinforce the sense that financial wrongdo- http://www.cftc.gov/reports/). ing during the crisis is most appropriately 19. See Abramowitz and Sack, “Why So Few Individuals? they tended to be smaller in scope. As a Government’s Prosecution of Corporate Misconduct.” result, companies did not report to the addressed through civil charges against insti- 20. See, e.g., United States v. Stein, 541 F.3d 130 (2d Cir. 2008) (holding that the government violated defendants’ government the fruits of extensive internal tutions. Whatever these cases reveal, claims Sixth Amendment rights by pressuring KPMG to cut off pay- of not doing enough are likely to follow. ment of individual employees’ legal fees). investigations, thus depriving the govern- 21. See Letter from Mark Filip, Deputy Attorney General, ment of important theories and leads in Despite the inevitable criticism, federal to Chairman Patrick J. Leahy and Senator Arlen Specter (July 9, 2008) (announcing changes to Justice Department’s Prin- building criminal cases. law enforcement agencies, including the Jus- ciples of Federal Prosecution of Business Organization in Beyond the relative absence of detailed tice Department and the SEC, have sought response to outcry over KPMG decision). internal investigations, the rules under to hold many individuals and institutions which the fruits of such investigations accountable for actions contributing to the financial crisis, just not in the manner that would be shared with the government Reprinted with permission from the September 4, 2013 edition of the NEW YORK LAW have changed dramatically following the the financial industry’s harshest critics JOURNAL © 2013 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382 or reprints@alm. KPMG-related litigation in the Southern would want—more criminal cases. com. # 070-09-13-03