Dallas-Fort Worth Real Estate Investor Club

APRIL 20, 2015
By PETER J. HENNING

Yogi Berra once said that “it ain’t over ‘til it’s over.” Unlike the final out or winning run in a baseball game, determining when cases arising from the 2008 financial crisis will end is a bit harder to discern. But the resolution of two cases last week clearly indicates that enforcement actions for conduct leading up to the crisis are pretty much done, with no real finding of liability for violations.

In one case, the Securities and Exchange Commission resolved fraud charges against Richard F. Syron, the former chief executive of the mortgage giant Freddie Mac, and two other senior executives related to statements regarding the company’s exposure to subprime mortgages. The case did not even end with the usual settlement in which the defendants neither admitted nor denied liability. Instead, it concluded only with an acknowledgment “that no party is the prevailing party.”

In the other case, the New York State attorney general, Eric T. Schneiderman, reached a $10 million settlement of accounting fraud charges against Ernst & Young for its role as the auditor for Lehman Brothers, whose collapse in September 2008 in the largest bankruptcy in American history ignited the near meltdown of the financial system. Although Mr. Schneiderman asserted that the resolution showed that auditors can be held accountable for violations, DealBook reported the accounting firm’s statement that “after many years of costly litigation, we are pleased to put this matter behind us, with no findings of wrongdoing by E.Y. or any of its professionals.”

Both cases took direct aim at conduct at the center of the financial crisis, and neither yielded anything close to a finding of actual wrongdoing.

The S.E.C. dropped its investigation into Lehman Brothers in 2012 despite an extensive report by Anton R. Valukas that concluded that management was aware of accounting maneuvers used to make its finances look stronger than they were. No one at the firm ever faced a civil action, much less criminal charges, and the modest payment by Ernst & Young looks more like a nuisance settlement.

In addition to the Freddie Mac defendants, three Fannie Mae executives, including its former chief executive, Daniel H. Mudd, were charged by the S.E.C. in December 2011 with the same type of violations regarding the company’s exposure to subprime loans. These were among the few cases to take aim at the management of a top player in the subprime mortgage market for its role in the financial crisis.

The problem the S.E.C. faced in the Freddie Mac case was that there was no accepted definition of a subprime mortgage, so proving that Mr. Syron and others intentionally made misstatements about the effect of those loans on the company’s portfolio was almost impossible. The case against the Fannie Mae defendants remains outstanding, but it is unlikely the S.E.C. will obtain much more than what it obtained from the Freddie Mac executives, which included total payments of $350,000 that were covered by the company’s insurance policy.

Prosecutors have been successful in using a provision of the Financial Institutions Reform, Recovery and Enforcement Act, better known as Firrea, to pursue civil cases against banks for violations of the mail and wire fraud statutes for misstatements about subprime loans bundled into securities that were sold to investors. JPMorgan Chase, Bank of America and Citigroup all paid multibillion-dollar settlements for Firrea violations. The law carries a 10-year statute of limitations, so cases from the financial crisis remain viable.

In February, Attorney General Eric H. Holder Jr. said in a speech at the National Press Club that he had given federal prosecutors 90 days to decide whether to file charges against executives for misconduct related to mortgage-backed securities. That deadline is fast approaching, and there has been no indication yet that a case will be filed against any individuals.

Banks have been willing to settle with hefty payments, but to date only one individual, a former executive at Countrywide Financial, has been found liable for a violation. Although Firrea remains a potent tool, evidence from the financial crisis is undoubtedly becoming stale because fraud cases, unlike fine wine, do not age well.

DealBook reported last November that prosecutors were considering filing civil charges against Angelo R. Mozilo, Countrywide’s former chief executive, but nothing has materialized. Mr. Holder’s 90-day deadline may push prosecutors to file a few cases against individuals, but the likelihood of any being pursued against a top Wall Street executive looks to be almost nil.

For all the billions of dollars paid in penalties by banks and Wall Street firms, the sense of dissatisfaction with how prosecutors investigated those involved in the financial crisis remains pervasive, especially when companies enter into multiple agreements that allow them to avoid charges for repeated misconduct but no individuals are named. The Justice Department has threatened to “tear up” a deferred or nonprosecution agreement if a company commits additional violations, but whether that will happen remains to be seen.

Even that shift drew a rebuke from Senator Elizabeth Warren, who described it in a speech last week as a “timid step.” For corporate misconduct, she said, “no firm should be allowed to enter into a deferred prosecution or nonprosecution agreement if it is already operating under such an agreement — period.”

With the era of financial crisis cases drawing to a close, the main lesson the Justice Department seems to have taken away is that the focus should be more on individuals who cause corporations to engage in misconduct rather than just the organizations themselves. In a speech last Friday at New York University, the head of the Justice Department’s criminal division, Leslie R. Caldwell, reiterated the point that the primary target will be those inside the company who are responsible for wrongdoing.

Federal prosecutors expect cooperation for corporate misconduct, but self-reporting will no longer be enough to consider a company to be cooperative. “True cooperation, however, requires identifying the individuals actually responsible for the misconduct — be they executives or others — and the provision of all available facts relating to that misconduct,” Ms. Caldwell said.

If anyone still had a notion that companies should be loyal to their employees, the Justice Department is trying to send a message that such feelings should fall by the wayside as prosecutors focus on culpable individuals in organizations. For companies, the dissatisfaction with the lack of signature cases from the financial crisis means increased pressure to cooperate, lest they be made an example of a new “get tough” policy.