Why Is It So Hard to Prosecute Wall Street Executives?

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Either the financial crisis was entirely an accident, the product of individual and institutional neglect, or somewhere along the way the wizards of the U.S. financial system allowed fraud to compromise their decision making.

It is a broad stroke, but an important one, and the late-2000s financial crisis, which triggered the deepest recession since the Great Depression, must be painted with it. Writing in the January 9 edition of The New York Review of Books, Judge Jed Rakoff of the Southern District of New York, explains why. If it was simply neglect, Judge Rakoff writes, then “criminal law has no role to play in the aftermath. But if, by contrast, the Great Recession was in material part the product of intentional fraud, the failure to prosecute those responsible must be judged one of the more egregious failures of the criminal justice system in many years.”

That is, if there was criminal wrongdoing, then where have the criminal prosecutions been? Wall Street has all but drowned in an ocean of finger pointing, and Judge Rakoff addresses the question that has cut through all the noise yet still lacks a compelling answer: Why have no high-level executives been prosecuted in relation to the financial crisis?

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Judge Rakoff argues, perhaps as much for the record as anything, that one reason why there have been no criminal prosecutions of high-level executives, in relation to the financial crisis, might be that no fraud was committed. At least, not in the upper-executive echelons of major financial institutions. High-level executives are, ostensibly, separated by at least one degree from the mortgage origination and securitization work that was at the front lines of any alleged fraud.

While he technically reserves personal judgement, Judge Rakoff neatly folds up this argument and many of its tangents and takes it off the table. He writes that, “The stated opinion of those government entities asked to examine the financial crisis overall is not that no fraud was committed. Quite the contrary. For example, the Financial Crisis Inquiry Commission, in its final report, uses variants of the word “fraud” no fewer than 157 times in describing what led to the crisis, concluding that there was a ‘systemic breakdown,’ not just in accountability, but also in ethical behavior.”

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Working from here, the conversation turns back to the headline question: why have no high-level executives been prosecuted in relation to the financial crisis? The answer, according to Judge Rakoff, boils down to a sort of institutional complacency among U.S. financial regulators, which was born out of an era of deregulation and matured in a post-9/11 environment, when the nation’s focus was on terrorism, not financial fraud.

It was a product of environment as much as anything else. When conditions are right — in the wake of Gramm-Leach-Bliley, with interest rates depressed by the Federal Reserve, and the federal government compelling Fannie Mae and Freddie Mac to purchase low-income mortgages — gamesmanship and the slide down the slippery slope into fraud should be expected.

Worse yet, this slide was either unseen, ignored, or under-investigated by financial regulators whose funding and staffing had been dramatically reduced. As an institution, U.S. financial regulators lost some of the knowledge and conviction necessary to pursue meaningful long-term investigations into fraud.

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Rakoff also suggests that, for a couple of reasons, it has become fashionable to pursue legal action against an entire business instead of just those decision makers that guided, committed, or allowed fraudulent behavior. “This shift has often been rationalized as part of an attempt to transform “corporate cultures,” so as to prevent future such crimes,” writes Rakoff. “But in practice, I suggest, this approach has led to some lax and dubious behavior on the part of prosecutors, with deleterious results.”

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