By: Chris Neill
Justice might finally be served for some of the last decade’s most egregious financial wrongdoings. Fabrice Tourre, a Goldman Sachs Vice President, was found liable in early August for misleading investors in an infamous synthetic collateralized debt obligation (CDO) deal. Two weeks later, charges were brought against two JPMorgan traders on Aug. 14 for their alleged involvement in the bank’s 2012 “London Whale” trading loss scandal. Finally, on Aug. 6, the Department of Justice filed a civil suit against Bank of America for alleged fraudulent mortgage lending practices leading up to the financial crisis. So are hoards of Occupy Wall Street protesters finally vindicated? Can mom-and-pop retail investors rest assured that the playing field has finally been leveled? Thanks in part to the glaring inadequacies of these cases, not really.
Fabrice Tourre was charged by the Securities and Exchange Commission with violating federal securities law in his work on a CDO deal known as Abacus. The deal was constructed from hundreds of residential mortgages and mortgage-backed securities, many of which bore an extremely high risk of default. The charges allege that hedge fund Paulson and Co. played a role in selecting the individual loans for the deal before taking a short position against Abacus. This positioned the fund to profit if the value of the deal fell, giving it incentive to knowingly fill the deal with subprime mortgages. Not surprisingly, the financial instrument tanked leaving those in the more traditional long positions who stood to profit if the value of the deal rose, out billions of dollars while Paulson and Co. profited.
Tourre played a large part in the construction of Abacus, and was apparently well aware of its risks. “The whole building is about to collapse anytime now,” Tourre wrote in an email, uncovered in the trial. “Only potential survivor, the fabulous Fab… standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstrosities!!!”
Despite Tourre’s “Vice President” title, he was merely a mid-level trader at an investment bank with thousands of other employees bearing the same title. The SEC can pat itself on the back all it wants, but it took down Goldman’s most unfortunate fall guy and missed an enormous opportunity to go after senior executives and make a meaningful impact. “There were thousands of people on Wall Street and beyond who helped inflate a fraudulent mortgage bubble,” writes the Washington Post’s Ezra Klein. “What differentiates Tourre from the others is that he was both smart enough to understand what he was actually going on, and dumb enough to brag about it in an e-mail. That was enough to earn the SEC’s wrath.”
Likewise, JPMorgan employees Javier Martin-Artajo and Julien Grout were charged by U.S. prosecutors for various crimes stemming from their mismarking of credit portfolios in order to minimize apparent losses. Meanwhile, Bruno Iskil, nicknamed the “London Whale” because of his massive credit portfolio, is not charged in the complaint due to his cooperation with investigators. Iskil claims to have been angered and in fact have attempted to “sound the alarm” while Grout and Martin-Artajo mismarked the $6.2 billion in losses from his recklessly massive trading positions.
When he eventually acknowledged the issue, JPMorgan CEO Jamie Dimon first called the incident a “tempest in a teapot,” and “an isolated event… something we don’t have to talk about by the end of the year.” In his 2013 annual shareholder letter, however, Dimon admitted, “The London Whale was the stupidest and most embarrassing situation I have ever been a part of.”
Are CEOs able to shirk responsibility for such prolific scandals in their companies, though? Financial blog ZeroHedge argues that blame should in fact stretch back across the Atlantic to Dimon himself, “for i) lack of supervision, ii) being completely unaware of what was going on in his firm, or worst iii) lying about what he knew, when he knew it, because for Jamie to be unaware for months about the ‘tempest in a teapot’ is something very few believe.”
Similar to Goldman Sachs and the case against Tourre, charges brought against the JPMorgan traders seem to represent a preference for safe, easy prosecution rather than larger and more meaningful legal action. Andrew Stoltmann, a Chicago securities lawyer, believes that prosecutors “have gone after the low-hanging fruit in terms of the charges,” and that “’a compelling argument could be made for charging JPMorgan or its senior executives “who misled investors on the size and scope of the losses.’”
Finally, although the Department of Justice is pursuing a civil suit against Bank of America for its alleged mortgage fraud, the Department comes up short in failing to pursue criminal prosecution against senior executives for the very acts of fraud described in the complaint. Paragraph 72 of the complaint specifically highlights the culture of dishonesty within the bank’s mortgage origination offices by referencing an employee who “admitted that the emphasis at Bank was quantity not quality and that he was pressured to increase the number of applications he approved per week.” The same employee also admitted that he received “bonuses for surpassing mortgage production goals.” A second employee admitted that “she and her co-workers were instructed by her superiors that it was not their job to look for fraud and stated that her job was ‘basically to validate the loans,’” and that “her superiors pressured her to process applications as quickly as possible but to keep her opinions to herself.”
But where did this perverse culture and compensation structure come from? Why were employees encouraged to originate loans that CEO Ken Lewis described as “toxic waste?” (The “toxic waste” not just referring to risky loans but loans that actually had a negative expected value; loans that “honest lenders” don’t make, according to law professor William Black). Paragraphs 23 and 24 of the complaint explain that executives at the bank, including the Senior Vice President and Managing Securities Director had annual bonuses which were “largely dependent on Defendants continuing to profitably securitize mortgages,” therefore creating “strong financial motive to withhold negative information … from investors.”
All of these allegations are clearly laid out in the complaint. Yet the DOJ chose to pursue a civil case against the bank as a whole despite acknowledging a culture designed by executives to encourage employees to originate poor-quality loans so that they may profit at the expense of investors and borrowers.
As America’s economy continues to recover from the 2008 financial crisis, the country slowly runs out of time to make any meaningful change so that history does not repeat itself. “Going after higher-level Wall Street executives is not so much a matter of retribution—though it’s understandable that many in the public would want that—but, rather, one of accountability,” writes the New Yorker’s Michael Santoro. The Goldman Sachs, JPMorgan and Bank of America cases demonstrate that as regulators continue to aim low rather than pursue more meaningful legal action, the window of opportunity for that accountability is closing.
