SEC Takes a Tougher, but Tricker, Line on Bank Misconduct
Opinion

SEC Takes a Tougher, but Tricker, Line on Bank Misconduct

Reuters/Jose Luis Magaua

Deny, deny, deny.

Over the years, a pattern has built up involving Wall Street’s alleged and actual misdeeds. On the one hand, financial institutions have forked over millions – sometimes tens or hundreds of millions of dollars – in fines. On the other hand, they have done so under the terms of settlements that don’t require them to admit any wrongdoing.

Now, the SEC is modifying that approach to some cases, demanding admissions of misconduct in cases such as JPMorgan’s “London Whale” trade. Being more aggressive is going to be tricky, though.

It’s true that the phrase “neither admitting nor denying” culpability causes those who spend their lives working on the Street or following its activities to roll their eyes. It’s a convenient little fiction, much like an investment analyst’s “hold” rating on a stock was back before Eliot Spitzer tried to bully Wall Street into vouchsafing their honest views of stocks. Just as everyone knew that a “hold” quite often meant “avoid at all costs,” so it’s an open secret on Wall Street that “neither admitting or denying” has a secondary meaning.

Of course, what that secondary meaning is, depends on which side of the aisle you occupy. On one side, inhabited by Wall Street’s critics, it translates to “Yeah, we did it, but you can’t force us to admit it.” From the point of view of Wall Street’s lawyers, it is more likely to be seen as, “We’re convinced we didn’t do anything wrong, but since the SEC can make our lives miserable for quite a while and cost us just as much in legal fees by time we get rid of this nonsensical allegation, we’re paying them to go away and let us get on with our lives.”

Over the years, this way of getting at least a measure of justice – that neither side was altogether happy with, but both could accept – came to be the norm because it worked for both sides. The “no admission, no denial” compromise enabled the SEC to fire warning shots across Wall Street’s bow. Regulators were able to collect millions of dollars in fines – a boon for any watchdog agency – and combine those financial deals with agreements banning certain individuals, deemed particularly responsible for the misdeeds, from the securities industry. That’s how the late Fred Joseph of Drexel Burnham Lambert and Salomon Brothers’ John Gutfreund won lifetime bans from serving as CEOs of Wall Street firms, and others, like Mike Milken, were banned from the industry for life.

Clearly, regulators came to believe that if they could get the individuals most at fault out of the way, it was fine to make a deal with the firm and its surviving leaders. When Salomon Brothers, for instance, cooperated with the government’s probe into the Treasury bond scandal in the early 1990s, the investment bank, after a temporary ban, was quickly restored to its status as one of a handful of primary dealers in the Treasury market.

Taking a case to trial, by contrast, is perilous for both sides. On the part of the regulators, it’s an expensive gamble. The guilty verdict in the Fabrice Tourre case was a lucky break for the SEC; often juries made up of laypeople struggle to understand some of the complex financial concepts at the heart of these cases. For a financial institution, a loss in court (or an admission of guilt in a settlement) can open itself up to a long list of other claims related – sometimes only tangentially – to whatever regulatory issue was at stake.

Despite those factors, Mary Jo White, the new SEC head, has said that some cases that the agency encounters require a greater level of accountability and a “no admission, no denial” settlement thus isn’t appropriate. Last June, top enforcement officers at the agency noted that “there may be other situations (that) justify requiring the defendant’s admission of allegations … or other acknowledgment of the alleged misconduct as part of any settlement.” Clearly, White saw the Tourre case (it was filed long before her arrival, but was litigated under her watch) as one of these, and that resulted in a victory for the agency.

Now, the SEC is taking a similar stand when it comes to J.P. Morgan and the London Whale trading losses. It will reportedly also announce charges as soon as this week against bank employees alleged to have tried to hide the value of the London Whale bets, though the Whale himself, trader Bruno Iksil, is not expected to be charged.

The pressure is on the SEC to take a tough stance when it involves such high-profile cases, even if pushing them to litigation will be risky and costly. In part, the SEC’s tougher new line is the result of outside forces. Members of Congress, under fire from their constituents (who don’t understand why none of Wall Street’s top bankers is languishing in jail alongside Bernie Madoff in the wake of the financial crisis) have asked some tough questions. And even the judiciary has weighed in, with Judge Jed S. Rakoff of Manhattan’s U.S. District Court refusing to sign off on a “no admission, no denial” case involving Citigroup without more information to demonstrate that the agreed settlement is appropriate, given the magnitude of the wrongdoing that the SEC initially had alleged was involved.

There is even a chance that a perceived need to litigate a greater proportion of cases brought by the agency will mean that, down the road, enforcement officials are wary of bringing cases they fear they may not win. The revisiting of the “no admission, no denial” policy calls out for a transparent discussion of what the SEC, the investment industry and the public feel to be the most heinous offenses – those that should always be litigated. Even then – even when the SEC believes that the actions of an individual or a firm not only violated securities laws but placed either the firm or a portion of the financial system itself in jeopardy – what follows may not make everyone happy.

Both the Tourre/Goldman Sachs and the London Whale/JPMorgan Chase have caught the public eye, but in reality, the two cases are quite different in terms of their implications for Wall Street. Fabrice Tourre’s actions at Goldman, in isolation, were careless and reckless, but also were fairly characteristic of the go-go environment of Wall Street at the time, and didn’t – in isolation – distort the functioning of a market, even if he didn’t do his full duty by his bank’s clients.

In contrast, the governance and risk management issues highlighted by the London Whale were potentially far more serious. And almost certainly, the bank is taking them more seriously than Goldman has treated the issues raised by the 2007 Abacus transaction at the heart of the Tourre case. Will an admission of wrongdoing help make the financial system more robust? Will charges against bank employees act as a deterrent next time? Or will it all just make us feel better for having delivered a much sharper rap to Wall Street’s knuckles?

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