Idle Promises......
Banks Promise Not to Commit Fraud ... Until Next Time
As part of a settlement with the SEC last month, Citigroup promised it would never again, as The New York Times put it, "violate one of the main antifraud provisions of the nation's securities laws." That seems like a noble aim, and we'd love to believe that Citigroup means what it says. Unfortunately, Citigroup made a similar pledge in July 2010, according to the Times. Oh, wait, and there were other agreements in May 2006, March 2005, and April 2000. When it comes to financial fraud, it seems, you can have five strikes, and still be up at the plate. And Citi isn't the only one. According to the Times' study, during the last 15 years, there were "at least 51 cases in which 19 Wall Street firms had broken antifraud laws they had agreed never to breach." Here is a complete list of 16 of those companies that declined to comment on the findings:
American International GroupAmeriprise
Bank of America Bear Stearns
Columbia Management
Credit Suisse
Deutsche Asset Management
Goldman Sachs
JPMorgan Chase )
Merrill Lynch
Morgan Stanley
Putnam Investments
RBC Dain Rauscher
Raymond James
UBS
Wells Fargo/Wachovia
This is pretty outrageous even by Wall Street standards, and it tells us a lot about our current regulatory system. If financial firms know that their promises to "not commit fraud" are meaningless, then we've created a culture where there is very little downside to unethical behavior and the aggressive pursuit of dubious new products. The SEC seems to be saying, "Hey, our lawyers are overmatched vis-a-vis these big firms. The best we can do is try to squeeze out a token settlement every once in a while, and call it a day." Surely our financial institutions know this, and probably view the occasional SEC wrist slap as the part of the price of doing business.
All hope is not lost, however. Just the other day a federal judge called into question the toothless practice of asking firms to make meaningless pledges to not break securities laws in the future. U.S. District Judge Jed Rakoff asked the SEC if these agreements were "just for show." He also made it clear that he had very serious concerns about the settlement between the SEC and Citi. He has yet to decide whether or not to approve the deal. One way or another, we need to ensure that in the future, financial fraud is treated like the serious crime that it is. Maybe the fines should include a few more zeroes at the end of them, and then double from there for future infractions. Remember the "zero tolerance" policy toward petty crime in New York City in the late 1980s and 1990s? Maybe we need "zero tolerance" for financial fraud on Wall Street in 2011 and beyond. Anything would be better than the current "zero effectiveness" approach. We can do better than this.
Hundreds Should Go to Jail
The law may not change the heart, but it can restrain the heartless."
-- Martin Luther King
For years now, heartless people have been running many of our world's banks and investment houses, and our laws have been insufficient to restrain them. Boards of directors, CEOs, and their leadership teams created incentive systems that rewarded self-interest, impatience, and bottomless greed. That's a deadly three-punch combo that can flatten employees, customers, and shareholders alike. And it has. So we should not be surprised to find that even as banks have toppled, even as tens of thousands of workers have lost their jobs, even as shareholders have been wiped out, and even as taxpayers are on the hook for trillions via future higher taxes or hyperinflation, the "leaders" of these organizations have continued to pay themselves obscenely. How obscenely? Despite losing $35 billion in 2008, Wall Street firms paid out $18 billion in cash bonuses!
Specific examples are more enlightening still.
Exhibit A
Washington Mutual CEO Kerry Killinger took home $88 million in the seven years preceding the collapse of the bank, which was later handed over to JPMorgan Chase at a 95% discount to prior highs. Killinger apparently designed a gimme-gimme culture fueled by reckless urgency and deceit. He hasn't returned a dime of his compensation.
Exhibit B
After leading AIG's credit-default swap unit, which lost $11 billion in one year, Joseph Cassano was allowed to keep $34 million in bonuses for the year. He was then hired for $1 million per month to consult the company on its maze of transactions. In total, Cassano was rewarded with more than $280 million for helping to destroy the world's largest insurer.
Exhibit C
During a 15-year period as CEO of Lehman Brothers, Richard Fuld lapped up hundreds of millions in rewards. That includes a $22 million retirement pay package in the year his company went under.
Exhibit D
A year ago, John Thain was given a $15 million signing bonus to take over at Merrill Lynch; in 2008, the company posted losses of $27 billion. Today, Merrill is widely considered a bankrupt subsidiary of Bank of America. Yet this December, Thain lobbied hard to be paid a $10 million bonus. And why not? His predecessor, Stanley O'Neal, received a $160 million retirement package after posting writedowns of $8 billion in a single quarter.
Hard as it may be to believe, there is no law that mandates the return of compensation when an executive's actions destroy a corporation. There's also no law that says you can't be heartless. Being soulless isn't criminal. And having no shame isn't actionable. To take legal action, federal authorities have to prove that these and other bankers had an intent to deceive. For example, if they can prove that Thain misled Bank of America before the acquisition, or that Thain and BofA misled regulators about the condition of the bank to secure bailout money, those points would be cause for prosecution. But in the many cases in which regulators won't be able to prove anything, we won't see orange jumpsuits on the hundreds of bankers for whom they would fit. Hundreds? Yes, certainly. At least that many. Remember that the banking sector has wiped out its investors, is decimating companies that rely on credit, and is primarily responsible for our rising unemployment.
So what are we left with, in terms of people who may go to jail? Well, there's Bernard Madoff -- whose deceit has spanned decades -- as well as what is certainly a team of shills. Early analysis of the accounting suggests that Madoff actually executed few, if any, trades. And in a true show of heartless cruelty, when Madoff was arrested, he had $170 million set aside not for the clients he had destroyed, but for friends, family members, and select employees. His lawyer is now being paid $1,000 per hour with client capital.
The search for confidence
What the markets need now, we hear every day, is confidence. Master investor David Swensen, head of Yale's endowment, said as much on The Charlie Rose Show last week. And of course, he's right. As we saw with the falls of Bear Stearns, Lehman Brothers, Washington Mutual, and Wachovia, lack of confidence leads to bank runs, bailouts, and bankruptcy. And when our banking system is crippled, there isn't enough confidence left for investors to fairly value even the most honorable organizations -- names such as Costco, Procter & Gamble, Berkshire Hathaway, and Johnson & Johnson.
But until there are new regulations in finance, there will be no rebound in investor or consumer confidence. Until the rules for the TARP plan restrict banks from paying bonuses during the deepest recession in decades, taxpayers will not stop getting angry. Until we see clear evidence that those who destroy companies will not benefit from their actions, we will continue to suffer the consequences of moral hazard. In short, until the market system looks meritocratic and constrained by ethics, why should we expect the mainstream investor and consumer to demonstrate confidence?