Looks Like the 1% is Going to Get Away with It

Peter J. HenningBy Peter J. Hennings

Last week turned out to be a good one for Goldman Sachs. The Justice Department closed a criminal investigation of the firm and its chief executive, Lloyd C. Blankfein, and the firm disclosed that the Securities and Exchange Commission had decided not to pursue a civil fraud case related to a subprime mortgage deal.

When the story of the financial crisis is finally written, this may turn out to be the denouement of the government’s investigations of Wall Street for potential wrongdoing that contributed to the financial crisis in 2008.

Permanent Subcommittee on Investigations

The criminal investigation was prompted by a referral from the Senate’s Permanent Subcommittee on Investigations, based on its 635-page report on the financial crisis that included details on Goldman’s transactions in mortgage-backed securities. The report highlighted potential conflicts of interest in how Goldman dealt with its clients and questioned whether Mr. Blankfein testified truthfully at an April 2010 subcommittee hearing when he said that the firm did not have a “massive short” position to bet on a decline the housing market.

In announcing the closing of the investigation, the Justice Department said that “based on the law and evidence as they exist at this time, there is not a viable basis to bring a criminal prosecution.”

Senator Carl Levin, Democrat of Michigan and chairman of the Senate subcommittee, expressed his displeasure at that outcome, noting that “whether the decision by the Department of Justice is the product of weak laws or weak enforcement, Goldman Sachs’s actions were deceptive and immoral.”

Whether it can ever be shown that a Wall Street trade is immoral, proving fraud requires more than just showing some measure of deception. Prosecutors also need evidence of intent, which can be hard to come by when a complex security is sold to sophisticated investors.

Investment banks like Goldman load their disclosure documents with plenty of generic disclaimers that can support a defense that no one sought to mislead buyers. It may not be so much a matter of weak laws as the requirement to show beyond a reasonable doubt that a defendant had the intent to commit a crime, a significant barrier to successfully prosecuting any fraud case.

And proving a perjury case is even more difficult because it must be shown that the defendant intentionally lied, not just that the testimony was incomplete or inaccurate. Whether Goldman’s position was “massive” or not looks to be a matter of degree, making it almost impossible to prove perjury.


The S.E.C.’s decision was a bit more surprising because the enforcement division told Goldman in February that it planned to recommend civil charges against the firm related to its sale of a $1.3 billion mortgage-backed security. Goldman had already settled allegations in 2010 about how it structured a collateralized debt obligation known as Abacus, so even if the S.E.C. had pursued another case, it was unlikely to contain any major new revelations about systemic misconduct.

Goldman is not completely out of the woods because it still faces a number of lawsuits over its mortgage operation, but the two greatest threats from government investigations are now behind it.

It does not look as if any other criminal cases against other banks are likely to emerge from the financial crisis now that four years have gone by. The Justice Department has already passed on cases against executives from firms like Countrywide Financial and the American International Group, and nothing else seems to be drawing the attention of prosecutors at this point.

At one time it looked as though the S.E.C. would pursue charges against executives from Lehman Brothers based on a report by a bankruptcy trustee claiming that the firm had misled investors by using accounting tricks to hide the amount of leverage on its books. But even that investigation appears to be winding down without any charges.

The S.E.C. may be wary of pursuing charges against individual defendants after an adverse jury verdict in a securities fraud lawsuit related to Citigroup’s sale of a C.D.O. The S.E.C. accused Brian H. Stoker, a director in Citigroup’s C.D.O. group, of negligently making misstatements in the offering documents that hid the bank’s bet that it would decline in value.

Where’s Waldo?

As a lower-level employee, he offered the “Where’s Waldo?” defense, claiming that he should not be the only one held responsible for misconduct by a huge institution. The loss in Mr. Stoker’s case may cause the S.E.C. to think long and hard about whether it can successfully prove individuals committed fraud in transactions conducted by Wall Street banks.

Without evidence showing significant involvement by senior executives and the prospect of the Waldo defense shielding other employees, the S.E.C. may be left with bringing cases only against firms, which are often happy to pay a fine to dispose of the matter – usually without admitting or denying liability.

So is the end of the Goldman investigation a matter of “weak laws or weak enforcement,” as Mr. Levin has asserted? We will never know what evidence the Justice Department gathered in its investigation, so it is hard to assess whether the decision not to pursue a criminal case was the result of prosecutorial reticence.

On the issue of the laws that can be applied, it would be possible to add inadequate disclosure of risks or a breach of a fiduciary duty to the list of securities crimes. But it is unclear whether Congress would be willing to enact laws to make it easier to pursue criminal prosecutions based on questionable ethics.

New laws would not make it any more likely that senior executives could be pursued unless they included liability as a “responsible corporate officer” for the conduct of underlings without having to prove an executive’s knowledge or recklessness.

Wall Street would be sure to put up quite a fight if expansive criminal prohibitions were introduced that made it easier to prosecute senior managers for the violations of lower-level employees. The pushback in Congress against the Dodd-Frank Act’s regulation of the financial sector shows that there may not be much appetite for additional government involvement in the financial sector.   Φ

Peter J. Henning is a professor at Wayne State University Law School, where he focuses on white collar crime, corporate and securities law and legal ethics. Before teaching, he worked at the Securities and Exchange Commission’s enforcement division and then as a prosecutor at the Justice Department. His latest book The Prosecution and Defense of Public Corruption: The Law & Legal Strategies has just been published.

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