November 29, 2021

As Wall St. Polices Itself, Prosecutors Use Softer Approach

Federal prosecutors officially adopted new guidelines about charging corporations with crimes — a softer approach that, longtime white-collar lawyers and former federal prosecutors say, helps explain the dearth of criminal cases despite a raft of inquiries into the financial crisis.

Though little noticed outside legal circles, the guidelines were welcomed by firms representing banks. The Justice Department’s directive, involving a process known as deferred prosecutions, signaled “an important step away from the more aggressive prosecutorial practices seen in some cases under their predecessors,” Sullivan Cromwell, a prominent Wall Street law firm, told clients in a memo that September.

The guidelines left open a possibility other than guilty or not guilty, giving leniency often if companies investigated and reported their own wrongdoing. In return, the government could enter into agreements to delay or cancel the prosecution if the companies promised to change their behavior.

But this approach, critics maintain, runs the risk of letting companies off too easily.

“If you do not punish crimes, there’s really no reason they won’t happen again,” said Mary Ramirez, a professor at Washburn University School of Law and a former assistant United States attorney. “I worry and so do a lot of economists that we have created no disincentives for committing fraud or white-collar crime, in particular in the financial space.”

While “deferred prosecution agreements” were used before the financial crisis, the Justice Department made them an official alternative in 2008, according to the Sullivan Cromwell note.

It is among a number of signs, white-collar crime experts say, that the government seems to be taking a gentler approach.

The Securities and Exchange Commission also added deferred prosecution as a tool last year and has embraced another alternative to litigation — reports that chronicle wrongdoing at institutions like Moody’s Investors Service, often without punishing anyone. The financial crisis cases brought by the S.E.C. — like a recent settlement with JPMorgan Chase for selling a mortgage security that soured — have rarely named executives as defendants.

Defending the department’s approach, Alisa Finelli, a spokeswoman, said deferred prosecution agreements require that corporations pay penalties and restitution, correct criminal conduct and “achieve these results without causing the loss of jobs, the loss of pensions and other significant negative consequences to innocent parties who played no role in the criminal conduct, were unaware of it or were unable to prevent it.”

The department began pulling back from a more aggressive pursuit of white-collar crime around 2005, say defense lawyers and former prosecutors, after the Supreme Court overturned a conviction it won against the accounting firm Arthur Andersen. That ended an era of brass-knuckle prosecutions related to fraud at companies like Enron.

Another example of this more cautious prosecutorial strategy: Government lawyers now go to companies earlier in an inquiry, and often tell companies to figure out whether improper activities occurred. Then those companies hire law firms to investigate and report back to the government. The practice was criticized last year when the Justice Department struck a settlement with Beazer Homes USA, a home builder accused of mortgage fraud.

This “outsourcing” of investigations — as some lawyers call it — has led to increased coziness between the government and companies, some critics say.

In banking, the collaboration is even stronger, dating to the mid-1990s when banks were asked to regularly report suspicious activities to the Treasury Department, an effort that aimed at relieving regulators of some of their enforcement loads. But it gave regulators a false assurance that banks would spot and report all wrongdoing, former investigators say. Moreover, companies are not as likely to come forward with evidence related to senior executives or to widespread patterns of misbehavior, some academics say.

Intended to make the most of the government’s limited investigative resources, the government’s cooperation with corporations and industry groups can work well and save money when business hums along as usual. But some veterans of government prosecutions question such collaboration in financial crisis cases, and contend they should have been pursued more aggressively.

“Traditionally, a bank would tell the Department of Justice when an employee engaged in crimes, but what do you do when the bank itself is run by a criminal enterprise?” said Solomon L. Wisenberg, former chief of the financial institutions fraud unit for the United States attorney in the Western District of Texas in the early 1990s. “You have to be able to investigate without just waiting for the bank to give you the referral. The people running the institutions are not going to come to the D.O.J. and tell them about themselves.”

A Clash of Agencies

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Your Money: Why 401(k)’s Should Offer Index Funds

This shouldn’t be a controversial statement. Yet it passes for one in Washington, where regulators and legislators are still mired in a never-ending debate over whether stockbrokers, certain insurance salespeople and others ought to meet that standard, known in legal circles as a fiduciary duty.

It is an important discussion, but there’s an even more essential one you ought to be having right now with your employer. There, the people who pick the mutual funds in your 401(k) plan are also supposed to be acting in your interest as fiduciaries, too, and may be failing to meet the letter, or at least the spirit, of that legal standard.

The task facing these well-meaning people is to construct your menu of investments carefully, while keeping a close eye on costs and risk. But many 401(k) plans do not offer a basic lineup of index mutual funds, which buy every security in a particular market segment rather than try to guess which small collection of individual ones will offer the highest return. These 401(k) plans lack index funds even though their low expenses and breadth make them the very definition of cheap and risk-conscious.

Instead, too many employees must choose among actively managed funds. Those investments tend to have higher costs, which eat away at returns. Active managers often have fewer stocks inside their funds as well, and that can create higher, more concentrated risks than index funds have.

While a judge has apparently never directly addressed whether a lack of index funds in a 401(k) plan may make it illegal, the people who oversee the retirement plans do not need to wait for a lawsuit to give employees the index investing option.

After all, if your plan lacks such funds, it may cost you well into the six figures by the time you retire. That’s because even if the two types of funds have the same return, you have to take the different costs into account. It’s enough to make it well worth your while to examine your own 401(k) or similar plan and request changes if you don’t like what you find.

So how do you make your case? First, a quick review of the research and the terminology.

Index funds buy every stock in a particular market, say all stocks in the Standard Poor’s 500-stock index. Active managers try to eke out a better return than index funds by buying, say, a subset of large United States stocks that they hope will outperform the collection of stocks in an index fund.

For the 20-year period that ended in December, 72 percent of actively managed mutual funds that invest in United States stocks (including those that closed during that time period) did worse than their benchmark index. In United States bond funds, the figure was 81 percent. International stock mutual funds showed similar results over a 15-year period.

These figures come from Vanguard, which may cause index skeptics to snicker, given the company’s close identification with index investing. Vanguard actively manages about 40 percent of the assets it controls, however, so it presumably has an interest in convincing people that those funds are worth choosing, too.

Some actively managed fund managers do outperform their benchmark index over long periods of time. But it’s awfully hard to figure out which ones will do so when they start funds, let alone which ones will continue to over your many decades of investing. Even so, people who pick the funds in your 401(k) menu make this sort of guess all too often. How are those people supposed to be conducting themselves? A law called the Employee Retirement Income Security Act, Erisa for short, offers some guidelines.

According to the law, the people who oversee your 401(k) plan are supposed to defray “reasonable” plan management expenses, minimize the risk of “large” losses and use the “care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”

One big reason index funds do better than actively managed ones is that they are much cheaper to run, since active managers spend a lot of money to conduct research and trade securities. So if cost is a consideration, index funds are usually the better choice.

As for the risk of large losses, the lack of big bets on any single security gives index funds an advantage, too. “Wouldn’t you rather, as a plan sponsor, invest with someone who focused on decreasing costs and decreasing risks, which are two factors over which they actually have control?” said W. Scott Simon, a principal with the 401(k) consultant Prudent Investor Advisors.

Things start to get hazier, though, when you try to pick apart this whole “prudent man” business. Such a person must consider “circumstances,” “like capacity” and “an enterprise of a like character.” It is, in short, an invitation to benchmark against other employers.

The problem with benchmarking, though, is that so many of the employers that someone might measure a 401(k) plan against aren’t necessarily giving their workers the best selection of investment options either. According to the Profit Sharing/401k Council of America, 82 percent of all plans offer a United States stock index fund as an option, 47 percent offer an international one and 54 percent offer a United States bond index fund.

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