A persistent criticism since the financial crisis hit has been the lack of any significant prosecutions of senior executives at the financial firms that received billions of dollars in taxpayer-financed bailouts. In Britain, the Parliamentary Commission on Banking Standards suggested adding a new law to allow the prosecution of British bank executives when they recklessly engage in misconduct that puts the bank and its customers at risk of severe losses.
It is an interesting question whether Congress should consider similar legislation to make it easier to hold financial executives criminally liable for decisions that can result in billions of dollars of losses, much of which may be borne by taxpayers as long as there are institutions considered “too big to fail.â€
One reason given by the Justice Department for the absence of any significant prosecutions of cororate executives is the difficulty prosecutors face in proving an individual’s specific intent to commit a crime. Lanny A. Breuer, the former head of the Justice Department’s criminal division, offered that explanation in a PBS “Frontline†special entitled “The Untouchables†about the lack of financial crime prosecutions: “But when we cannot prove beyond a reasonable doubt that there was criminal intent, then we have a constitutional duty not to bring those cases.â€
This is especially problematic when chief executives and other officers may be well removed from the actual decisions tha! t led to the losses. They can plausibly assert their ignorance about what actually happened. When authority is diffused through an organization, it can be almost impossible to hold anyone accountable.
The British proposal would obviate at least some of that difficulty by using a lower threshold to allow a conviction if the government proved that an executive recklessly engaged in misconduct. Under American law in general, recklessness is defined as consciously disregarding a substantial and unjustifiable risk of harm from conduct that is a gross deviation from what a reasonable person would do. A defense of “I didn’t know†can be more easily overcome if the person should have been aware of what was happening but charged headlong into risky transactions.
There is nothing comparable to the British proposal in the United States to prosecute this type of financial misconduct by executives. At one time, the federal mail and wire fraud statutes were used against corporate leaders who breached th duty of honest services that involved conflicts of interest and other actions that put their own interests ahead of those of an employer.
Among those prosecuted under this theory was Jeffrey K. Skilling, the former chief executive of Enron. The Supreme Court used his case to limit honest services fraud prosecutions to only instances of bribery and kickbacks, not more general corporate mismanagement that caused harm to the enterprise through dishonesty. Mr. Skilling’s sentence was reduced by 10 years last week in exchange for his dropping any further appeals in his case.
With the honest services fraud theory off the table, few options are available to pursue corporate executives for misconduct that does not require proving the higher level of intent bemoaned by the Justice Department.
Civil enforcement actions by the Securities and Exchange Commission can be brought for reckless violations, and some fraud violations require only proof of negligence. But even that lower threshold has proved to be a challenge in cases arising from the financial crisis.
For example, a jury found in favor of Bruce Bent Sr. for his statements about the stability of the Primary Reserve Fund, a money-market fund whose meltdown during the financial crisis unnerved investors, even though the S.E.C. had to prove only negligence. Similarly, a former Citigroup middle manager was cleared of securities fraud charges under the same standard for his role in selling a collateralized debt obligation tied to subprime mortgages that lost much of its value within months of its issuance. The S.E.C. has a trial scheduled next month against Fabrice Tourre, formerly of Goldman Sachs, for his role in peddling a faulty security that will present a significant challenge in whether it can prove he was reckless.
Adopting a statute along the lines of the parliamentary commission’s recommendation might have some modest deterrent effect on financial executives, who could fear that they might be made an example by prosecutors seeking to hold someone accountable for a bank’s failure. Whether that would make them overly timid in how they manage the bank’s operations by avoiding any risk of failure is one plausible response.
Requiring proof of recklessness would not necessarily mean that more executives would be prosecuted successfully for the type of deciions that led to the financial crisis. The recommendation for the new crime in Britain candidly admits that “all concerned should be under no illusions about the difficulties of securing a conviction for such a new offense.†The parliamentary commission also said that this new authority could be used only when there are substantial costs imposed on taxpayers or the threat of serious harm to customers, a fairly small class of cases.
In the end, the frustration expressed over the lack of any prominent criminal prosecutions of bankers that captured the public’s imagination like the case against Mr. Skilling may be less about the standard for proving a violation than finding proof to link executives to decisions that were clearly criminal. For all the talk about how the financial crisis must have entailed fraud, much of the conduct during that period seemed to involve a headlong rush into risky transactions without understanding the consequences. Whether that was misconduct or just stupidity ! is not an! easy question to answer.
The British proposal for a new crime of reckless mismanagement would give prosecutors another tool to use in the next financial crisis. A lower standard for proving intent might encourage the government to take on tough cases because it would be harder for financial executives to offer up their ignorance or good faith about the details of risky transactions as a shield against being held responsible.
But a new criminal offense would not have any effect on the financial crisis of a few years ago because the Constitution prevents applying a new law to old conduct.
