By William K. Black
Kilkenny, Ireland: November 8, 2014
Wall Street’s full depravity was put on display in Joseph Fichera’s November 6, 2014 op ed in the New York Times. I hasten to add that the reason that the op ed is so revealing is that Fichera is one of the sometimes good guys who, for example, accurately warned that “auction-rate securities” were a dangerous scam and criticized JPMorgan’s odious abuse of Denver. When the Ficheras of the world join in Wall Street’s “race to the bottom” Federal Reserve Bank of New York’s President Dudley’s point about the corrupt culture that characterizes Wall Street is proven irrefutably.
Let’s begin by reviewing the bidding. We have just suffered through the third economic crisis driven by epidemics of control fraud. In two of the crises the financial industry led the fraud epidemics. In the Enron-era fraud epidemic they eagerly aided and abetted Enron’s frauds. In the current crisis we know that U.S. government investigators have found that 16 of the largest banks in the world conspired to falsify Libor, which is used to price $350 trillion in assets. This is the largest cartel in world history by at least three orders of magnitude. Note that all 16 of the banks that participate in creating Libor falsified their statements for the express purpose of falsifying the Libor “fix.” There were no honest banks and there is no reason to believe that if 25 banks participated in setting Libor the results would have differed. The conspirators are not known to have blackballed any bank from participating in “fixing” Libor because of fears that the blackballed bank was led by an honest CEO who would expose and end the conspiracy.
Government investigators have found that over 20 of the largest banks defrauded Fannie and Freddie by selling them vast amount of toxic mortgages through fraudulent “reps and warranties.” Government investigators have found that over 20 of the largest banks defrauded a series of credit unions by selling them toxic mortgages and toxic mortgage derivatives through fraudulent reps and warranties. Government investigators have found other wide ranging frauds by the large banks to (1) rig bids for issuing municipal securities, (2) to foreclose on people through fraudulent affidavits, and (3) by conspiring to falsify foreign exchange (FX) rates. In sum, the leaders of the largest banks in the world are overwhelmingly leading criminal enterprises that commit financial frauds of unprecedented scope and damage. The resulting financial crisis caused by the three most destructive fraud epidemics in history caused over a $21 trillion loss in U.S. GDP and the loss of over 10 million American jobs. Each of those figures is much larger in Europe.
Worse, no senior banker who led the three fraud epidemics has been prosecuted in the U.S. for those crimes. Virtually no senior bankers who led the three fraud epidemics has even been the subject of a civil suit by the U.S. Virtually no senior banker in the U.S. has had his fraud proceeds “clawed back” by the government or the bank. The senior bankers were made wealthy through the “sure thing” of accounting control fraud – with nearly perfect impunity from the criminal and civil law.
This is the setting in which Fichera writes. As a sometimes good guy, one would expect his column to call for the Department of Justice (DOJ) and the SEC to end this impunity and immediately act vigorously to hold the senior bankers personally accountable for leading the frauds that blew up the global economy. Instead, Fichera wrote to urge (1) that the largest banks be treated as “too big to jail,” (2) to decry the “tendency to vilify all Wall Street firms as unscrupulous,” (3) to urge SEC sanctions to be reduced to the level of “DMV” “points,” and (4) to provide that no matter how egregious the fraud the SEC would have no power to remove a Wall Street firm’s license until it committed “multiple” cases of the equivalent of deliberate homicide in which each case could involve deliberately running over millions of investors. Under Fichera’s plan, every dog would get at least one bite – of every investor – which would mean hundreds of thousands of bites. Fichera wants banks to be – officially – entitled to commit securities fraud without effective sanction from the SEC.
Trivializing Elite White-Collar Crime
Henry Pontell and I have written often about efforts to trivialize even the most elite white-collar crimes. The goal is to strip such crimes of their moral content and treat them as – at most – the equivalent of traffic violations. Fichera’s proposal seeks to do precisely that to accounting and securities fraud – just after such frauds blew up the global financial system. Honest securities firms would want exactly the opposite in order to prevent a “Gresham’s” dynamic.
“[D]ishonest dealings tend to drive honest dealings out of the market. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence” (Akerlof 1970).
A “legitimate business” would demand a strict rule of law to prevent “dishonest dealings” by its rivals. As the government investigations I referred to above demonstrate, the Gresham’s dynamic has driven our largest “legitimate [financial firms] out of existence” and those that remain are overwhelmingly those who gained and maintain their competitive advantage through “dishonest dealings.”
Fichera reveals his true preferences when he shills for the elite financial CEOs leading the world’s largest and most destructive financial institutions and seeks even weaker regulation. He seeks to maximize the already powerful Gresham’s dynamic.
“The S.E.C. should use its regulatory powers (which provide for public input) to create a transparent, D.M.V.-style point system. If a broker-dealer or an investment bank earned too many violations over, say, a six-year period, its securities license would be suspended.
Regulators would have a new enforcement tool with which to negotiate settlements or pursue prosecution — but banks would also know, well in advance, how and when they could lose their license; only multiple violations over time would trigger the penalty. Banks with an otherwise clean record would be protected from being brought down by exceptional misconduct by rogue employees.”
Fichera also wants the SEC to “forgive points” if it does not discover and take enforcement actions against new frauds by the financial firm within six years of the time they were last caught committing securities fraud.
“Just as the D.M.V. forgives points if a driver keeps a clean record for a certain number of years or takes a remedial class, wrongdoers could get the slate wiped clean. The tendency to vilify all Wall Street firms as unscrupulous would fade.”
This is a great system. I can’t wait for it to be applied to muggers who prey on Wall Street traders. A mugger will have to wait six years after getting caught battering and robbing a Wall Street trader (which will be a small percentage of the times they mug) for their “slate [to be] wiped clean.” I’m sure that if the muggers who specialize in attacking Wall Street traders only get caught every six years “the tendency [of bankers] to vilify all [muggers] as unscrupulous would fade.” But this doesn’t capture the true spirit of Fichera’s DMV plan. His plan proposes that the SEC “forgive points” if the mugger “takes a remedial class” that teaches that it is not appropriate to mug. And if you like a DMV point system for muggers you’ll love one for sex offenders that target your children, girlfriends, and spouses.
I can hear some of you saying – “but mugging and sexual molestation are real crimes” while defrauding people that trust you of tens of billions of dollars is just like driving without buckling your seatbelt. Accounting and securities fraud are really close to being victimless crimes, if one ignores a few million fraud victims who foolishly believed you when you said you were a fiduciary representing them as your principal.
There is the embarrassing fact that the faux fiduciaries love to target your widowed grandmother for their financial frauds. Indeed, they particularly like to target them in the early stage of suffering from Alzheimers’ while Grandma can still write checks and has no family guardian appointed. But heck, why does Grandma need a family guardian to protect her from Wall Street brokers who bear her “a fiduciary obligation which must be faithfully and punctiliously observed?” Sorry, I went into a time warp there and forgot that Delaware has evolved beyond the archaic concept of “faithful and punctiliously observed” fiduciary obligations.
How’s Delaware’s evisceration of fiduciary duties working out for Wall Street morality? When the head of the NY Fed laments that the Nation’s largest banks have a corrupt “culture” you might think that Wall Street and Delaware leaders might go back to principles that served the Nation and the financial industry well for so many decades. No, even the sometimes good leaders of Wall Street urge a DMV points system specifically designed to rend the threadbare remnants of morality in finance. The words “moral” and “ethical” are never mentioned in Fichera’s op ed because the true goal of his DMV “points” plan is to remove any ethical or moral component to Wall Street recurrently defrauding your Grandmother. As in The Godfather, it’s not personal; “it’s just business” when they target your Grandmother for their fraud schemes and sales of grossly unsuitable products. Morality and ethics are so the “60’s.” Modern finance is increasingly a value-free game in which the CEOs ensure that the players are overwhelmingly callow males thrust into “death cage” style competitions for money, promotion, and prestige with other callow male rivals. The purpose of those competitions is to produce a Gresham’s dynamic in which bad ethics drives good ethics out of the firm and the industry. The callow males view everyone else as simply a potential “mark.” When they rip off your Grandmother they chortle – or they leave the industry in disgust. In fairness to the callow males, tens of thousands of them have left the industry in disgust. Sadly, hundreds of thousands stay.
Fichera Identifies Two Criminogenic Changes by Bank CEOs
Fichera admits that two major changes instituted by Wall Street CEOs have proven exceptionally criminogenic, encouraging widespread accounting and securities fraud, but he does not want to reverse the changes.
“Why aren’t billion-dollar penalties enough? Before 1999, most commercial and investment banks were separate. Investment banks were partnerships where every dollar lost came directly from the partners’ pocketbook. Moreover, being tainted by regulators could drive business away or even destroy the firm, as happened with Drexel Burnham Lambert in 1990 after the company pleaded guilty to illegal trading.
Now, commercial and investment banking are consolidated behemoths. Revenues and profits expanded exponentially, diluting the impact of any one penalty. More important, shareholders replaced partners (who are personally liable), as investment banks became publicly traded corporations.”
The first change was the de facto repeal of the Glass-Steagall Act which had worked brilliantly for a half century before being gutted by hostile anti-regulators, particularly Alan Greenspan. The second change was to take the investment banks “public” and eliminate the “joint and several liability” of their partners which had worked brilliantly for over a half century. When investment bank, audit firms, and attorneys were partnerships in which the general partners bore “joint and several liability” for all the partnership’s debts should it fail those partners had powerful incentives to monitor each other to ensure integrity and excellence. They also had strong incentives not to make someone a partner unless they had mentored him for years and were confident that he was a person of the highest integrity and competence.
Fichera does not mention the other contemporaneous institutional change that proved so criminogenic. Modern executive and professional compensation are typically designed by the CEO to create perverse incentives that can generate a Gresham’s dynamic.
The three salutary institutional factors were combined with real fiduciary duties and real SEC enforcement during the time I was a young attorney in private practice. The result was a financial system that was the envy of the world. Note that the combination is designed to prevent a Gresham’s dynamic and to replace it with an upward race to quality in ethics and competence.
But here’s the kicker – Fichera does not propose to fix any of these criminogenic institutional changes that have led to history’s three most destructive epidemics of accounting control fraud. He knows the changes have proven disastrous, he knows how to fix the problem by reversing those changes – and he makes no suggestion to remove the criminogenic environment. He doesn’t reject fixing the institutional problems he identifies. He simply ignores the concept of fixing the problem. This is nuts.
Fichera Bemoans the Failure of a Large Criminal Enterprise
The quotation above has a strange statement that appears to bemoan the failure of Drexel Burnham Lambert.
“[B]eing tainted by regulators could drive business away or even destroy the firm, as happened with Drexel Burnham Lambert in 1990 after the company pleaded guilty to illegal trading.”
Drexel was not “tainted by regulators.” It was “tainted” by the felonies led by its (de facto) controlling officer, Michael Milken. Drexel’s frauds “destroy[ed] the firm” – not the regulators – unless Fichera is making the claim that Drexel should not bear legal responsibility for the crimes of its most powerful officer.
Fichera Supports Kid Glove Treatment of the Largest Fraudulent Banks
Fichera even supports the concept of “too big to jail” or “bar.”
“The worries expressed by Attorney General Eric H. Holder Jr. that some banks might be “too big to jail,” and by the S.E.C. commissioner Kara M. Stein that some are “too big to bar,” are real, because the principles of regulation and justice sometimes conflict. Steep penalties, like suspending a license without warning, can punish innocent employers [WKB: Fichera probably meant “employees”] and shareholders. That happened when the accounting firm Arthur Andersen was convicted of obstruction of justice in 2002 and went out of business. Tens of thousands lost their jobs because of the crimes of the few who were involved in Enron’s financial fraud.”
Fichera could not be more wrong – and more revealing of why the “sometimes good” elements of Wall Street cannot be relied upon to clean up its intensely criminogenic environment. First, no banker is ever “too big to jail” or “too big to bar from securities or banking. Second, no “bank” can be “jail[ed].” Third, no matter how big the bank it can be placed in receivership or have its senior managers “removed and prohibited” when they are leading frauds or unsafe and unsound practices. Fourth, the “principles of regulation and justice” do not conflict when we hold elite frauds accountable for their frauds through prosecutions, receiverships, and removals and prohibition orders. Indeed, “the principles of regulation” are: (1) create incentive systems and controls that minimize fraud and unsafe and unsound practices, (2) to remove from any position in which they can endanger the bank, customers, or the public, and (3) to prosecute the most elite criminals to increase deterrence and use enforcement and civil actions to ensure that no senior officer gains a penny from leading the frauds and unsafe and unsound practices. Vigorously pursuing justice not only does not “conflict” with “the principles of regulation” – it is essential to achieving “the principles of regulation.”
Fichera’s Unprincipled Oxymoron about “Principle”
What is clear is that when Fichera uses the word “principles” he means “unprincipled.” Fichera has forgotten the most fundamental principle of justice expressed in the famous Latin maxim:. Fiat Justitia Ruat Caelum (Let Justice be done, though the Heavens Fall).
Fichera considers the ancient Latin principle hopelessly naïve, and the fact that he does so demonstrates further that he does not understand that there is nothing more practical than consistently seeking justice through the legal and regulatory systems. Financial crises occur when we abandon the maxim, betray justice, and decide that some elite banks and bankers are so big or so politically powerful that they must be de facto immune from effective regulation and prosecution. A society that deliberately abandons justice and the principles of regulation in order to protect large banks and powerful bankers is a Nation that will see the heavens fall. A Nation that abandons justice encourages massive fraud by the wealthy and powerful and guarantees recurrent, intensifying economic crises and a descent into crony capitalism. There is nothing more practical for a person or a Nation than leading a principled life.
Only elite financial sector officers believe that they and their banks are entitled to being exempted from the rule of law. Normal human beings are nauseated when they read such claims. The reason that Fichera’s ode to the unprincipled life is so distressing is that he was believed to be in the top 10% of the distribution of financial sector CEOs when it came to integrity. That indicates how depressingly deep the rot runs among Wall Street’s CEOs.
Fichera shows a bizarre affection for fraudulent bankers.
“Steep penalties, like suspending a license without warning, can punish innocent employers and shareholders.”
The phrase “suspending a license without warning” is strange. The SEC can suspend licenses of securities firms that engage in securities fraud. Every securities firm’s leaders knows that the SEC has this power. Every securities firm’s leaders knows that if he allows or directs the firm to commit fraud the SEC may suspend its license. The CEOs have all the “warning” they need not to commit fraud.
The concluding clause is even more disturbing. Recall that the context was Arthur Andersen’s (AA) collapse after giving clean audit opinions to the financial statements of one of the most fraudulent firs in history – Enron. Enron’s controlling officers led an accounting control fraud. Neither Enron’s nor AA’s controlling officers lacked a “warning.”
Conclusion: Note the Argument Fichera Chooses Not to Make
Fichera’s point seems to be that AA should still be operating because it was so large that it had many honest shareholders. Under his own proposal, however, AA would have been eliminated prior to 2002 through the suspension of its license by the SEC. Indeed, that should have been Fichera’s argument – my DMW point system would have driven AA out of business a decade earlier and prevented it from giving clean opinions to roughly two dozen major accounting control frauds. After all, AA gave clean opinions to a series of the worst frauds before and after it aided Enron’s frauds. Surely, under his point system, it would have been mandatory for the SEC to have suspended its license no later than the 1990s. Even the Wall Street Journal wrote an extensive article explaining how AA’s controlling officers embraced new non-governance measures that proved criminogenic by impairing AA’s once storied integrity. A study found that AA’s audit quality declined materially relative to the other members of what was then the “Big 5” audit firms (none of whom demonstrated great integrity).
Fichera, of course, could have made a powerful argument based on the WSJ article and the study that his DMW point system – because it would have mandated the suspension of AA’s license – would have put AA out of business far earlier and saved immense losses to “innocent [employees] and shareholders” by stopping those elite AA fraudsters before they did far more damage to employees and shareholders by aiding and abetting dozens of accounting control frauds. However, arguing that his DMV system would speed mandatory, severe sanctions against the firm (suspension of its license) would require Fichera to admit the truth – that such sanctions reduce harm (on a system-basis) “to [employees] and shareholders.” Fichera, given a choice of arguments, chose (again) to argue for weaker regulation and enforcement – particularly for large banks and their controlling bankers.