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Never doubt that a small group of thoughtful, committed citizens can change the world. Indeed it is the only thing that ever has.
Margaret Mead
My recent article, What Shall We Do With The Big, Bad Banks, noted how over the last 15 years, some 19 large major financial institutions have been found by the SEC to have broken anti-fraud security laws at least 51 times—laws that they agreed “never again to breach”. The group of offenders included Citigroup [C], Bank of America [BAC], JPMorganChase [JPM], UBS [UBS] Goldman Sachs [GS], Wachovia [WB], and AIG [AIG]. In this period, the Securities and Exchange Commission (SEC) has never once brought a contempt of court citation against any of the banks for repeated offences.
The party ends
Yesterday, Judge Jed S. Rakoff of US District Court in Manhattan took a stand. He rejected a $285 million settlement between Citigroup and the Securities and Exchange Commission, in which, once again, Citigroup admitted no wrongdoing and promised “never again to breach the law”.
Judge Rakoff said that he could not determine whether the agency’s settlement with Citigroup was “fair, reasonable, adequate and in the public interest,” as required by law, because the agency had claimed, but had not proved, that Citigroup committed fraud.
According to the SEC, Citigroup created a $1 billion mortgage fund that it sold to investors in 2007 and filled it with securities that it believed would fail so that it could bet against its customers and profit when values declined. The fraud, the agency said, was in Citigroup’s falsely telling investors that an independent party was choosing the portfolio’s investments.
The SEC, Judge Rakoff said, “has a duty, inherent in its statutory mission, to see that the truth emerges.” But it is difficult to tell what the agency is getting from this settlement “other than a quick headline.” Even a $285 million settlement, he said, “is pocket change to any entity as large as Citigroup,” and often viewed by Wall Street firms “as a cost of doing business.” While $285 million sounds like a lot of money, it compares to the $700 million that investors lost and the $160 million that Citigroup made from the deal.
A practice hallowed by history not by reason
Robert Khuzami, the SEC's director of enforcement, said that the decision “ignores decades of established practice throughout federal agencies and decisions of the federal courts.”
Judge Rakoff’s response was that the established practice makes no sense. It is “hallowed by history, but not by reason”and creates substantial potential for abuse.
In his decision, Judge Rakoff called Citigroup “a recidivist,” or repeat offender, for having previously settled other fraud cases with the agency where it neither admitted nor denied the allegations but agreed never to violate the law in the future. Citigroup and other repeat offenders can agree to those terms, the judge said, because they know that the commission has not monitored compliance, failing to bring contempt charges for repeat violations in at least 10 years.
A comfortable club
Judge Rakoff put his finger on a comfortable arrangement that has been going on for many years. A bank commits a fraud and makes a lot of money. The SEC brings a suit for fraud, but settles the case while the bank admits no responsibility and offers a “never again” promise. The judges blesses the agreement. The SEC declares victory. The bank continues with business as usual and commits another fraud. The SEC brings suit and so on, ad infinitum.
Almost everyone is happy. The judges are saved from a series of messy and expensive trials. The SEC gets a headline and a fine. The banks can continue with business as usual.
Who loses? First, the investors suffer continuing losses, as they have little chance of bringing a successful suit against Citigroup when the SEC is unable to extract the slightest admission of doing anything amiss.
Second, the taxpayers also suffer when they are called up on bail out the big banks when the practices become so egregious that they endanger the entire global financial system.
Third, the shareholders also suffer big losses. Citigroup has lost 92 percent of its share value over the last ten years.
The really big winners in this wonderfully comfortable club are the bank executives and traders. Even in 2010, just two years after banks like Citigroup were bailed out by the taxpayers, compensation for the 29 largest financial organizations was an astonishing $135 billion. (That’s billion, not million.)
What if others followed Judge Rakoff’s example?
Other judges are not obligated to follow Judge Rakoff’s opinion.
“The crucial question,” worries Peter Henning in the New York Times, “is whether Judge Rakoff’s decision has led to an end to the S.E.C.’s policy of settling its cases without any admission of liability by the defendant? Although Judge Rakoff is only one federal district judge, his approach may be influential with other judges who do not wish to be seen as mere 'rubber stamps' for the S.E.C.”
What if other judges began rejecting questionable settlements that effectively give a green light to "recidivists" to continue with business as usual?
What if the SEC developed a backbone and started bringing contempt of court cases for “recidivists” like Citigroup?
What if business schools started teaching that maximizing shareholder value systematically results in declining shareholder value?
What if investors wised up just a tad and grasped that investing in banks that systematically “disadvantage’ their customers is a very poor investment decision?
What if banks themselves started to realize that disadvantaging their customers does not make long-term business sense? What if they sent their traders back to Las Vegas where they could continue their taste for gambling without risk to the public, and started focusing their business on activities that would grow the real economy?
What if the banks even began to find ways to delight their customers by practicing radical management?
Would it be so terrible if judges began living more authentic lives by actually implementing the law, and bankers started living lives that were personally worthwhile?
And what if that led to an end to financial crises and in due course to a rebirth of the real economy and the growth of jobs: would that be such a horrible thing?
And read also: The World's Dumbest Idea: Maximizing Shareholder Value
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Follow Steve Denning on Twitter @stevedenning
