DOJ and SEC Step Up Enforcement of Subprime Fraud

Following the subprime mortgage meltdown, an issue repeatedly raised by commentators and the public at large is the Administration’s lack of prosecutions of high-ranking members of the financial sector.  The key question seems to be whether the government will be able to hold any of the major players in America’s financial institutions responsible for a financial crisis cause in part by reckless lending and excessive risk taking by major financial institutions.   60 Minutes did an excellent report on the topic in December 2011 that you can watch here.  

More recently, the Department of Justice (DOJ) and the Securities and Exchange Commission (SEC) have taken enforcement actions that have targeted some big names in the financial industry. 

               

In February 2012, the SEC charged four former Credit Suisse Group investment bankers and traders for engaging in a scheme to fraudulently overstate the prices of $3 billion in subprime bonds at the height of the subprime credit crisis.  In a press release, the SEC alleges that the traders priced subprime bonds in a way that enabled Credit Suisse “to achieve fictional profits.”  Moreover, the SEC also alleges that the traders mispriced bond prices to hit daily and monthly profit targets, which was driven, in part, by “these investment bankers’ desire for lavish year-end bonuses.”  The case is currently pending in the U.S. District Court for the Southern District of New York. 

Likewise, the DOJ has been busy.  Recent press articles report that the DOJ is investigating possible fraud at General Electric Company’s former subprime mortgage Unit, WMC Mortgage Corporation.  The DOJ and FBI are investigating whether senior managers condoned practices that enabled fraudulent loans to be sold to investors during the height of real estate boom.  Specifically, unidentified sources state that government is investigating whether WMC used falsified paperwork, and overstated borrowers income, among other acts, to push through questionable loans.  

The public’s demand for more enforcement actions related to the subprime mortgage crisis is unlikely to abate any time soon.  The difficulty of successfully prosecuting a financial case should not be underestimated.  The authors of “Observations on the Dearth of Criminal Prosecutions After the Financial Meltdown” provide a useful analysis of the challenges prosecutors face.  The authors discuss U.S. v. Ferguson where the SEC successfully charged and convicted Wall Street executives for securities fraud only to have the case thrown out of federal appeals court.  The authors draw a few lessons from Ferguson.  They argue there is a general consensus that “prosecutors face an uphill battle, while defense attorneys’ jobs have gotten slightly easier.”  Moreover, “it is often extremely difficult to prove the criminal intent of the executives.”  The authors conclude that while public pressure may compel more prosecutions of high-ranking financial officials responsible for the financial crisis, it is “equally likely” that the reversal in Ferguson may discourage prosecutors from acting. 

The public is justifiably upset.  However, as U.S. v. Ferguson demonstrates, the chance for failure in cases involving complex securities fraud is a big disincentive.  The other challenge the government faces is that the people they would prosecute can afford the best representation money can buy.  Financial Fraud Law recently reported that one big D.C. based firm has gone so far as to establish its own “Financial Fraud Enforcement Task Force” to counter the Obama Administration’s Enforcement Task Force that was established over two years ago.  To add, prosecutors face many of their former colleagues who have recently jumped to the private sector to, presumably, cash in on their experience as prosecutors by representing the people that could be the target of the government’s efforts.  Financial Fraud Law has documented the transfer of state and federal financial fraud prosecutors to private firms specializing in white collar criminal defense.  This all goes to show that the obstacles prosecutors face are substantial.  While we should not let the government off the hook for holding those accountable who committed fraud, we can at least understand why it may take longer than we would like for justice to be served. 

Ted Serafini

Blogger, Criminal Law Brief

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