Fines Imposed by Capital Markets Agencies Drop Precipitously in First Half of ‘17: What Does This Signify?

As reported by The WSJ, fines imposed by the SEC, CFTC, and FINRA, the primary self-regulatory securities organization, all dropped dramatically in the Trump Administration’s first half-year compared with the first half of 2016. Total fines levied by these three agencies totaled nearly two-thirds less. Is this a mere coincidence with the new Administration’s initiatives to deregulate the financial markets? Fines have dropped in other sectors of the economy as well. The Washington Post notes that the Administration has collected 60% less from civil penalties for environmental wrongdoing than the administrations of the three previous presidents did on average in their first six months in office. What are the implications for the future of enforcement and compliance in financial institutions?

The data should not be taken at face value. The dramatic decline as far as the finance industry is concerned can be ascribed to a number of factors, whose contributions cannot be easily teased out: new chiefs at the three agencies as well as heads of enforcement have recently changed, some of whom have only recently started their job; the administration’s recent deregulatory pronouncements thus far remain only that; the senior officials behind the SEC’s “broken windows” policy, which punished even minor infractions, are no longer at the agency; both federal agencies had vacancies which made approval of both routine and high-profile enforcement actions challenging; and lastly, the hefty fines resulting from financial-crisis related fraud have skewed year-over-year comparisons.[1]

Even when viewed superficially, however, is the decline in fines necessarily a bad omen for financial institution compliance and risk management? Jay Clayton, the new SEC Chair, makes some intriguing observations. He correctly notes that fines imposed on companies themselves come at the expense of their shareholders. He has voiced his opinion that it is better to penalize the responsible individuals. Moreover, he has  indicated he intends to focus on intentional wrongdoing rather than unintentional regulatory violations, on “individual accountability” over corporate penalties.

Over the last decade the government has entered into deferred and non-prosecution agreements, accompanied by eye-popping penalties, but high-placed agents have not been found guilty of nor admit to criminal wrongdoing. Fines assessed in the U.S. against financial institutions relating to the financial crisis now amount to more than $150 billion.

A change in policy that focuses more on prosecuting individual executives and holding them accountable would be for the good, even at the expense of lower fines. The spate of multibillion-dollar penalties against banks for fraudulent sales of mortgage-backed securities prior to the financial crisis ultimately draws on “other people’s money,” to use Justice Brandeis’ phrase. Brandeis was pointing to an egregious example of the “principal-agent” problem inherent in the corporate form of business organization, which can result in a divergence between the interests of the agents – the senior executives and members of the board of directors – and the interests of the corporation and its shareholders. They, the agents, control the use of the money that belongs to the shareholders, the owners. They generally face little downside if their bets with the money go wrong but enjoy a considerable upside in terms of share-based compensation if their bets are good. It’s typically little skin off the back of the chairman of the board or the CEO. In 2012, despite more than $900 million in fines, Jamie Dimon’s bonus was halved to a only $10.5 million, while his $1.5 million salary remained intact, following JPMorgan’s $6 billion London Whale trading scandal. (The criminal charges against two of the bank’s executives involved in the scandal recently were dismissed.)

Criminally prosecuting the executives responsible for the wrongdoing would, in Samuel Johnson’s apt phrase, “concentrate the mind wonderfully.”[2] It would be a powerful corrective to the principal-agent problem. Two years ago, Sally Yates, until recently a senior U.S. Justice Department official, in part responding to the growing criticism of the Department’s lack of individual prosecutions, instructed the government’s field attorneys, among other things, to withhold a company’s cooperation credits for assisting in an investigation unless it provides information on individuals involved in the alleged wrongdoing and to focus on individuals from the very beginning of an investigation. The jailing or civilly prosecuting their peers would concentrate the minds of executives at the highest echelons of a corporate hierarchy, causing them to allocate more resources and management attention to internal risk management controls and compliance systems. It would also realign prosecution with its original deterrent function on moral grounds. Judge Jed S. Rakoff, U.S. District Judge for the Southern District of New York, has put the case for individual accountability perhaps the most cogently:

I suggest that the future deterrent value of successfully prosecuting individuals far outweighs the prophylactic benefits of imposing internal compliance measures that are often little more than window-dressing. Just going after the company is also both technically and morally suspect. It is technically suspect because, under the law, you should not indict or threaten to indict a company unless you can prove beyond a reasonable doubt that some managerial agent of the company committed the alleged crime; and if you can prove that, why not indict the manager? And from a moral standpoint, punishing a company and its many innocent employees and shareholders for the crimes committed by some unprosecuted individuals seems contrary to elementary notions of moral responsibility.[3}

Fines against entities had become the default option of the capital markets agencies. It is much easier for regulators to convince the executives to use company earnings to pay a fine than taking them to trial, which they will fight tooth and nail. Nevertheless, it is hoped that the new agency heads will vigorously implement the new policy as highlighted by Chairman Clayton. “If a corporation is engaged in illegal practices they should not be able to buy themselves out of accountability,” says Christy Goldsmith Romero, the inspector-general of Sigtarp, which oversees government bailout funds.

[1] Jean Eaglesham, Dave Michaels, and Danny Dougherty, “Regulators’ Penalties Against Wall Street Are Down Sharply in 2017,” WSJ (Aug. 6, 2017).

[2] “Depend upon it, sir, when a man knows he is to be hanged in a fortnight, it concentrates his mind wonderfully.” Boswell’s Life of Johnson.

[3] Judge Jed S. Rakoff, “The Financial Crisis: Why Have No High-Level Executives Been Prosecuted?,” The New York Review of Books (Jan. 9, 2014). Judge Rakoff was the keynote speaker at a conference on compliance in financial institutions hosted at Chicago-Kent College of Law in March of this year.

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