Tide's Out
An expected wave of financial-crisis prosecutions hasn't hit yet.
The American Lawyer
By Vivian Yee
November 01, 2009
Multiple governmentagencies, from New York state attorney general Andrew Cuomo, to the U.S. Department of Justice, to the Securities and Exchange Commission, are all digging vigorously through the ruins of the financial markets. In July SEC chief Mary Schapiro told members of the House of Representatives Committee on Financial Services that the SEC had opened 439 investigations so far this year, compared to 395 last year, and issued over two times the number of subpoenas. According to a Justice spokeswoman, the Federal Bureau of Investigation is investigating more than 2,100 mortgage fraud cases, an increase of nearly 400 percent from five years ago.
But the tsunami of indictments and lawsuits that white-collar defense attorneys expected in the wake of the financial crisis hasn't hit yet. "While there have been a lot of reports about stepped-up activity by enforcement agencies, so far, there may be less than meets the eye," says Davis Polk & Wardwell partner Carey Dunne. Several practitioners say they're keeping busy with investigations and billing at least the same number of hours as they were last year, but haven't seen the level of prosecutions increase dramatically.
Investigations, of course, take time, and a change in government represents further delay. "Any time you're adding to an agency with new personnel, there's going to be a learning curve in terms of understanding the agency's priorities as well as how it operates," says Shearman & Sterling partner Steven Molo, noting the leadership changes at the SEC and the U.S. Attorney's Office for the Southern District of New York.
But there's a bigger challenge facing all of the regulators. Given the scope and complexity of the meltdown, enforcement agencies are in the perplexing position of having to connect the run-of-the-mill mortgage fraud at the bottom of the crisis to Wall Street banks. To successfully prosecute bankers and consultants at large financial institutions, the government must show that they were aware that the exotic mortgage-backed securities they were trading were worthless at bottom, that they were purposely overvaluing mortgage pools. "The challenge for the agencies is to come up with a unified field theory of liability, a theory of fraud that will tie the disparate products and players into a coherent explanation of why falling home prices in the United States led to a worldwide financial meltdown," Dunne says. Compared to past white-collar scandals like options backdating or accounting fraud, this collapse is much harder to compress into a neat sound bite for a jury.
Enforcement agencies seem to be unsure how aggressively they can prosecute bankers for making risky bets that added up to billions of dollars in losses and led to the subprime crisis. "Sharing widespread bad judgment doesn't amount to a violation of law," says Debevoise & Plimpton litigation cochair John Kiernan, so "regulators are understandably being careful sorting through whom they intend to impose legal blame on." But even the number of small individual prosecutions for relatively straightforward crimes — such as insider trading — is lower than expected, several white-collar attorneys say.
One clue to investigators' current thinking is the Justice Department antitrust division's probe into data provider Markit Group Holdings Ltd., the leading reporter of credit derivative prices, which is partly owned by big banks. The government may hope to accuse investment banks of colluding to artificially prop up the prices of credit derivatives over the past few years, The Wall Street Journal reported in July. Markit declined to comment.
So while the government may be ramping up investigations into investment banks, whether they'll ultimately paint these bad investments by Wall Street bankers and traders as wrongdoing is unclear. "The parlor game for the white-collar bar is trying to predict how many, if any, of these investigations will lead to criminal prosecutions," says Kramer Levin Naftalis & Frankel partner Barry Berke. Enforcement agencies are still figuring out the rules of the blame game.
