FINALLY, IN APRIL 2010, the SEC announced that it had a case. It filed charges against Goldman Sachs for the Abacus collateralized debt obligation. The case alleged that Goldman had failed to disclose the involvement of a hedge fund (which intended to short, or bet against, the security) in the portfolio selection process. This news gave us hope that the SEC was back on the job and that even the most powerful on Wall Street would be held accountable. In Ted’s eyes, Khuzami, who oversaw the case against Goldman, was a hero. Until the day he left office, Ted would continue to encourage and defend Khuzami.
When the SEC settled with Goldman that summer for a record $550 million, many thought Goldman had gotten off easy. Ted, however, rushed to Khuzami’s defense in a posting on the New York Times DealBook. He wrote that the fine is evidence the SEC is “back on the beat.” Khuzami had taken on Goldman Sachs, “the ultimate in a sophisticated, powerful defendant with access to armies of the best lawyers and deepest pockets to defend any case. . . . Whatever you might think about the deal, no one should believe Goldman walked away with anything less than a very bloody nose.”
Ted went further out on a limb, personally vouching that the SEC and Justice Department were fully invigorated, well led, motivated, and determined to root out financial fraud associated with the financial crisis, even among the highest paid and most influential. We so wanted to believe that they were.
During the next four months, no noteworthy cases emerged, only settlements (for trifling sums) engineered by the SEC. The settlements angered a number of federal judges, who lambasted the SEC for letting individuals off the hook and failing to achieve adequate deterrence. When I later raised the judges’ objections privately with Khuzami, he said to Ted and me: “I’m not losing any sleep over them.” I retorted: “Why not? It seems to me they’ve put the key question squarely on the table: Is the SEC achieving the level of accountability and deterrence that the facts demand?” Khuzami merely glared at me and went back to talking to Ted.
What had gone wrong? When Ray Lohier (now a judge on the Second Circuit, U.S. Court of Appeals, but during 2008–09 the assistant U.S. attorney in the Southern District of New York in charge of the securities-fraud division) made his courtesy visit to members of the Judiciary Committee in the spring of 2010, he met with Ted and me. Ted asked him, “What is your current top priority?” Lohier responded, “Cyber crime.” Our jaws dropped. For the last eighteen months, we’d been vociferously prodding the Justice Department to target high-level Wall Street fraud. But the message still hadn’t gotten through to the man who had held the key position. Hacking into a Wall Street bank’s computers to steal money is a crime. It should be investigated and prosecuted. But what about the banks’ potentially fraudulent actions that harmed so much of the rest of the country?
The truth is, the Justice Department never made investigating these actions a high priority. It never formed strike forces of investigators and lawyers that had sufficient resources and backing to doggedly pursue the obvious potential wrongdoers as long as it took to bring a fraud case. This view was substantiated by subsequent reporting by George Packer at the New Yorker and Gretchen Morgenson and Louise Story at the New York Times. Indeed, it wasn’t long before the Justice Department leaked to the media that it wasn’t going to bring indictments against Joseph Cassano, a former top executive at AIG, or Angelo Mozilo, former chief of Countrywide. Why so soon and so publicly? I knew of people who’d been harassed by prosecutors for years and were never told they were off the hook. So I was surprised that department lawyers had swiftly announced that central players in the financial crisis were in the clear.
At the time, the U.S. Attorney’s office for the Southern District of New York (SDNY) was successfully prosecuting a number of big insider-trading cases. Though laudable, these cases had nothing to do with the financial crisis. Wiretaps had produced ample and damning evidence of insider trading, so perhaps the SDNY had decided to focus on this productive avenue of prosecution. But I suspect the decision stemmed, at least in part, from the fact that the SDNY never felt it had the full backing of Justice Department leadership to devote massive resources and time against major Wall Street actors in the financial crisis. Indeed, even though the SDNY is by far the best-equipped U.S. attorney’s office for conducting sophisticated securities-fraud investigations, the department had spread responsibility for these investigations to other smaller and less-experienced offices. What’s more, Attorney General Holder also gave the SDNY high-profile, resource-draining terrorism cases like the prosecution of Khalid Sheikh Mohammed, the mastermind of the 9/11 plot (this decision unleashed a firestorm of criticism, and Holder, seventeen months later, reversed it). This mattered, I believed, both because of the resource drain (subsequently alleviated) and because of the message it sent about what was important (just like in the immediate aftermath of 9/11).
Why didn’t the department provide the necessary leadership? I wish I knew. Were Rahm Emanuel and Geithner against aggressive investigation and prosecution? Geithner has said publicly: “The stuff that seemed appealing in terms of . . . Old Testament justice . . . penalize the venal, would have been dramatically damaging to the basic strategy of putting out the panic, getting growth back, making people feel more confident in the future. . . .” Seemed appealing? Absolutely necessary, in my view. Geithner’s statement would seem to indicate that he believes utilitarian outcomes justify overlooking potentially criminal behavior by banks.
I suspect that Attorney General Holder, who always has an ear cocked to the White House, got the essence of Geithner’s message. Rahm was well known for making hundreds of phone calls a day, directly or through proxies, to micro-manage the administration. Moreover, friends of mine who worked in the White House confirmed to me that no one in the Justice Department ever made high-level financial fraud cases a priority.
If the White House, Geithner, and Holder thought they faced a binary option—pursue financial fraudsters vigorously (thereby jeopardizing the economic recovery) or feign vigor but actually do nothing besides levying a few paltry fines (thereby not jeopardizing the economic recovery)—they were wrong. Individual executives, not the firms for which they worked, could’ve been singled out and prosecuted without disrupting the banks’ ability to recover. The fact that no individuals were being held accountable left us with a Wall Street thoroughly mistrusted by Main Street.
Of course, government lawyers can point out that they were the only people in a position to see the evidence and to have a preview, from opposing counsel, of the target’s defense. Because disclosures were made (they were just buried deep in the prospectuses) and because accountants and lawyers had signed off on the transactions, the Justice Department can assert that prosecution, no matter how aggressive, would’ve failed. In my opinion, the department was too deferential to the white-shoe law firms defending potential targets: If the highly paid defense team said the target’s behavior wasn’t illegal, they bought it (or at least believed that a jury would). If Obama had appointed aggressive trial lawyers (and Biden knew plenty of them) to these Justice Department positions and backed their efforts, there’s a good chance they would’ve hunted the worst Wall Street fraudsters relentlessly.
Before Ted left office, he wanted another opportunity to have Breuer, Perkins, and Khuzami testify publicly. In late September 2010, he called them before a second FERA oversight hearing, determined to get answers. Gaveling the hearing to begin, he said: “I will say right now that I’m frustrated.” He wanted to know whether the Justice Department had the “infrastructure, personnel and strategies in place” to find criminal conduct on Wall Street. After expressing obligatory praise for how “incredibly hard” government investigators had been working, he asked why there had been no “senior officer or boardroom-level prosecutions of the people on Wall Street who brought this country to the brink of financial ruin?” Looking straight at Breuer, he continued:
Why is that? Is it because none of the behavior in question was criminal? Is it because too much time passed before investigators got serious, so the trail has gone cold? Is it because the law favors the wealthy and powerful? Or is the explanation more complex? Are there systemic challenges that the agencies are finding difficult to overcome? . . . Is the fine print exculpatory?
Predictably, Breuer dodged Ted’s questions and instead proffered generalities (“The department has engaged in a robust and comprehensive investigation”), statistics on garden-variety financial fraud cases (“between October 2009 and June 2010, nearly three thousand defendants were sentenced to prison for financial fraud, and more than sixteen hundred of these defendants have received sentences of greater than twelve months”), and details of recent cases that had nothing to do with Wall Street and the financial crisis (“on September 15, 2010, Nevin Shapiro, the former CEO of Capital Investments USA Inc., pleaded guilty in Newark, New Jersey, to fraudulently soliciting funds for a non-existent grocery distribution business”). Sitting behind Ted, I tried hard not to roll my eyes as Breuer touted the successful prosecution of a grocer for a small-time New Jersey Ponzi scheme. He was ducking the main issue and continuing to assure Ted and the rest of the committee that the department was being “thorough” and “robust” in its effort to bust big-time fraudsters.
To the department’s credit, the U.S. attorney in the Eastern District of Virginia, Neil MacBride (a former Biden chief counsel), had recently indicted Lee Bentley Farkas, the former CEO of Taylor, Bean & Whitaker Mortgage Corporation (TBW). TBW was once one of the largest private mortgage companies in the United States. Farkas was charged with perpetrating a massive fraud scheme that resulted in losses exceeding $1.9 billion and that contributed to the failure not just of TBW, but also of Colonial Bank, one of the fifty largest U.S. banks before its collapse in 2009 (in June 2011, Farkas was sentenced to thirty years in prison and fined $38.5 million). That was the only significant case Breuer could point to.
In his testimony, Khuzami was more clear and detailed. He at least separated the cases the SEC had brought into two categories: those related to the financial crisis (like civil actions against Goldman Sachs, Citigroup, State Street, and several other major players) and those unrelated to the crisis (like Ponzi schemes and insider trading). Khuzami stressed that in the last nine months the SEC had brought enforcement actions (and obtained hundreds of millions of dollars in settlement penalties) against companies and individuals that:
There they were. All the illegal behaviors that we had long believed had taken place during the financial crisis. But the SEC was dealing with these cases by bringing civil actions, which only have to be proved by a preponderance of the evidence (unlike criminal cases, which only the Justice Department can bring and every element of which must be proved beyond a reasonable doubt). Moreover, the SEC was settling these cases (and levying comparatively trifling fines) rather than proving the allegations in court. That meant that the banks didn’t have to admit to any wrongdoing, which enhanced their ability to defend themselves against private civil actions and denied the public a sense of closure.
During Q&A, Breuer finally got close to saying something interesting. He explained that “from the simplest to the most complex” case, there must be a “materially false statement” where the defendant “can’t point to something” to show his innocence. “Falsehood and criminality” are what we need to prosecute. So why not take us through the obvious potential defendants, I thought, and just come out and say it? This theory wouldn’t work against target X because he could point to Y disclosure buried deep in the documents. That theory wouldn’t work against target W because W could point to an exculpatory e-mail Z. This would’ve helped an outraged citizenry to better understand why the Justice Department was repeatedly deciding not to prosecute.
Because we knew that Breuer would say it would be improper to discuss the results of a specific federal investigation, Ted tried to gain clarity by using a hypothetical. He talked about a bank in the mortgage-origination business that, in an effort to maximize market share and raise profits, had decided to secretly relax its underwriting standards to a greater and greater degree, with the result that a large majority of its loans (particularly its riskiest loans to the least qualified borrowers) were liars’ loans. He pressed the panel of witnesses, particularly Breuer, for an answer: “What if this hypothetical bank knowingly issues widespread exceptions to its published underwriting standards, while at the same time claiming to would-be purchasers of mortgage securities that the underwriting standards had been substantially complied with?” He waited for an answer, but Breuer deferred to Khuzami as the expert. So Kaufman tried a new tack with Breuer:
Or suppose [the hypothetical bank] determines that a class of mortgages that it has held for its own investment are likely to default in the near future and seeks to offload these mortgages onto third parties. That might not be a crime, but what if the bank has claimed to purchasers that it has not selected mortgages for sale based on a belief that they are likely to default?
Breuer again deferred to Khuzami. Using variations on his hypothetical, Ted tried repeatedly to achieve a clearer understanding of the difference between merely reckless conduct and criminal conduct. But no matter how Ted framed the question, Khuzami (not Breuer) simply reiterated the basic elements of an action for a materially misleading statement or mentioned theories regarding accounting violations (although with regard to Countrywide, he did say that the theory was that the company’s executives knew their business model was deteriorating and allegedly should’ve disclosed this as a trend and an uncertainty).
In his effort to help the country understand why there had only been settlements of civil cases but, despite the available evidence, no criminal prosecutions, Ted was getting nowhere. And he was getting no assistance from Breuer, who confined himself to generalities. The Justice Department seemed to have handed the job of financial-crisis-related fraud to the SEC. For its part, the SEC seemed to be focusing on resolving allegations through civil-law settlements and comparatively painless monetary fines. But this approach, I believe, was the mere semblance of accountability under law. Moreover, it did little to help the country put the financial crisis behind it or allay its mistrust of Wall Street.
Ted was now more frustrated than before the hearing. But he remained convinced, by what he’d learned from many sources (including the PSI hearings held by Senator Levin), that serious criminal behavior had occurred as well. And he was determined that it be brought to light:
Widespread cheating and fraud, of the sort that drove the speculative housing and derivative securities bubbles, are anathema to public confidence in the markets. In order to assure investors, and the public, that we have learned our lessons from the last disaster, we must have a full account of the criminality that led us there.
Ted’s voice became husky with emotion as he concluded his remarks. “This November, I will leave the Senate and the task of oversight will fall to my colleagues. I encourage each of you to keep up the hard work, to keep digging into offerings documents, e-mails, board minutes. To keep developing leads through whistleblowers, plea deals and tip hotlines. I am confident that you will.”
Despite my concerns, I wanted to believe Breuer’s assertion that the Justice Department’s investigation was “comprehensive” and “robust.” After the hearing, I walked up to him at the witness table and said, “It’s always reassuring to hear you say these things publicly.” If he was going to come before a Senate committee and sound like Eliot Ness, he’d better produce some significant cases; otherwise, in hindsight he’d look like he’d just been Kevin Costner reading his lines.
Yes, it’s difficult to prove criminal intent in cases of financial fraud, especially when a defendant relied on professional advice from accountants and lawyers (and in some cases may even have been acting with the knowledge of the bank’s regulator, who was apparently more concerned about the bank’s financial soundness than about full disclosure to investors). But we shouldn’t outsource the interpretation of fraud laws to a potential defendant’s accountant and lawyers. And why haven’t prosecutors used provisions in the Sarbanes-Oxley Act, which put in place tough criminal sanctions in the wake of Enron and other cases of massive corporate frauds? In the absence of an aggressive, targeted effort by the Justice Department, we’ll never know whether crimes may have been proved beyond a reasonable doubt.
Ted and I had come to the Senate with the idea that the Justice Department should form a number of financial-fraud strike forces. We worked on giving them additional funds, and took Holder and Breuer at their word when they said they would make these cases a top priority. In hindsight, I wish we’d required the department to provide us with a monthly update of how many prosecutors and investigators it had working full-time on different potential cases. Maybe that would’ve been oversight overkill (and we were also aware of the inappropriateness of a senator asking about particular cases). But the fact is, not enough effort was put into investigation and prosecution.
I also wish Chairman Leahy had taken the lead in holding the Justice Department’s feet to the fire and that other senators had cared more, too. Ted was a freshman senator, transitory, and not on the Appropriations Committee, as Leahy was. We thought we were doing effective oversight, but, when it was over, I felt misled and gamed by the Justice Department.
As I became more and more concerned about the lack of Wall Street prosecution, I asked Ted on several occasions why he didn’t just “ask Biden to call Holder and get the debrief on what is going on? If Biden tells you he’s convinced that all that should be done is being done, that’s good enough for me.” Ted, who had forty years of experience in shielding Joe Biden from criticism, just changed the subject. I wasn’t close enough to Biden to do it myself. Other Biden insiders would probably explain that the Justice Department is outside Biden’s “zone of influence” (the Obama team never gave Biden the opportunity to place his people in the Justice Department or White House Counsel’s office). They’d go on to say that, from the beginning of his vice presidency, Biden is lucky not to have been muzzled and rendered irrelevant, and that it’s a huge success story that he’s been able to do as much as he has. I think that’s true, but still a poor excuse. Biden could pick up the phone at any time, call Holder, and ask about resources and the progress on pursuing financial fraud. Biden is a former trial lawyer, former chairman of the Senate Judiciary Committee, and proud of his thirty-six-year history on civil and criminal justice issues. At the height of my frustration at the absence of indictments, I said to Ted: “Why don’t you call your friend Joe Biden and tell him to stick a hot poker up the Justice Department? The buck stops one door down from him.”
Even as I uttered the words, I knew they were useless. I knew what we were up against. I’d been in these trenches before. I’d watched the relationship between Washington and Wall Street evolve over more than twenty years, and I didn’t like it. In the Clinton administration, as special assistant to White House Counsel Abner Mikva, I’d watched Wall Street flex its hypertrophic muscles. And I’d seen how Wall Street can defeat even the president of the United States.