March 29, 2024

DealBook: The Limits of Bigger Penalties in Fighting Financial Crime

President Obama called for tougher penalties for corporate crime.Charlie Riedel/Associated PressPresident Obama called for tougher penalties for corporate crime.

President Obama, in a speech last week, called for strengthened oversight and accountability of financial firms by increasing the punishments that can be imposed for criminal violations. This comes on top of a recent proposal by Mary L. Schapiro, the chairwoman of the Securities and Exchange Commission, to ratchet up the available civil penalties for violating the securities laws.

Seeking greater punishments for white-collar offenders gives the impression the government is taking steps to prevent crime, but there is a substantial question whether these proposals will have any appreciable impact on deterring future violations. The problem is not so much the penalty that can be imposed but proving a violation so that the punishment can be meted out. The paucity of criminal prosecutions from the financial crisis shows that the real difficulty lies in gathering evidence to prove a crime took place.

In his speech in Kansas, Mr. Obama said:

“Too often, we’ve seen Wall Street firms violating major antifraud laws because the penalties are too weak and there’s no price for being a repeat offender. No more. I’ll be calling for legislation that makes those penalties count so that firms don’t see punishment for breaking the law as just the price of doing business.”

What type of penalty would “count” is unclear because financial firms have already been fined significant amounts, like the $550 million civil penalty imposed on Goldman Sachs for selling a mortgage-bond related security. Whether that type of penalty deters future misconduct remains to be seen.

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Severe sanctions that would put a company out of business — a corporate death penalty — seems unfeasible in the current economic environment when the net result would be significant job losses for lower-level workers who had nothing to do with the violations.

Before any punishment for financial misconduct can be imposed, the government must prove an intentional violation, which in a criminal case requires proof beyond a reasonable doubt. That is often the rub, because the perceived financial “crimes” committed by Wall Street firms and others believed responsible for the financial crisis would involve showing intent to defraud, a difficult standard to meet.

The recent collapse of MF Global is a good example of just how hard it will be to prove criminal violations. A lawyer for the bankruptcy trustee said that the apparent loss of more than $1 billion in customer money was the result of “suspicious” transactions. The New York Times reported that there were multiple instances in which customer money was used to keep the firm afloat, perhaps going back as far as August 2011.

In his testimony last week before the House Agriculture Committee, Jon S. Corzine, MF Global’s former chief executive, said he had no idea how the customer money disappeared. He asserted that he “never intended to break any rules,” and that if any employee claimed the transfers were at his direction, then he was “misunderstood.”

This is the classic defense offered by senior corporate officers when there is wrongdoing at a firm, that they were not directly involved and therefore did not have the intent to mislead. Any decision to transfer customer money likely involved multiple layers of corporate management, meaning that fingers can be pointed elsewhere if no one had the primary responsibility for the decision.

The final days of MF Global appear to be marked by desperation to save the firm, and it is unlikely anyone thought about the potential penalties that could be imposed if they violated the law. Many financial frauds start small, with individuals cutting corners to keep the company afloat or make a quarterly number, all in the hope that once things stabilize they can make it right again. Even the accounting fraud at Enron started out with just reaching for those last few pennies of earnings to meet Wall Street’s estimates, and it grew from there.

Substantial prison terms have been imposed for violations of the antifraud laws in the last few years. The hedge fund manager Raj Rajaratnam received 11 years for insider trading, the longest sentence for that violation ever given, and Zvi Goffer, a former trader at Mr. Rajaratnam’s Galleon Group, received 10 years for the offense. In the most prominent mortgage fraud prosecution to date, Lee B. Farkas, the former chairman of Taylor, Bean Whitaker, received a 30-year prison term for causing losses the government estimated at $2.9 billion.

Along the same lines, in a $205 million health care fraud case, in September a federal judge in Miami gave a 50-year sentence to a former executive of a mental health company. And Bernard L. Madoff received perhaps the highest sentence ever for fraud: 150 years.

It is difficult to conclude the penalties available under the law for committing financial crimes are somehow lacking. Most financial frauds involve multiple violations that can be charged as separate crimes, so the potential punishment is often quite high, even for corporations that can only be subjected to fines. But corporate cases rarely even get to court because prosecutors are willing to allow companies to enter into deferred or nonprosecution agreements in which the punishment is agreed to in advance.

Congress has already pushed for higher sentences through Section 1079A of the Dodd-Frank Act, which directed the United States Sentencing Commission to review the sentencing guidelines for securities and financial crimes to ensure they reflect the impact of the offenses. So there is already pressure to ratchet up the recommended punishment for corporate fraud.

Higher recommended sentences may not result in great punishments because not all federal judges are willing to impose significant prison terms on white-collar offenders who often have otherwise sterling reputations and present little threat of future violations. The sentencing guidelines are not mandatory, so judges are largely free to draft sentences they consider appropriate.

Just increasing potential prison terms or fines may not have any appreciable impact in deterring fraud, given the difficulties of proving a financial crime and the differing views of judges on the appropriate punishment for a white-collar offender. That is especially true in cases like insider trading where it is hard to identify any individual victims and the defendant may be an executive with a record of charitable contributions.

Although President Obama asserted that Wall Street firms have violated “major antifraud laws,” the assumption that crimes occurred is easy to make but much more difficult for prosecutors to prove. And even if a crime can be established, it is not clear that just authorizing even greater punishments will have any real effect in deterring wrongdoing.


Peter J. Henning, who writes White Collar Watch for DealBook, is a professor at Wayne State University Law School.


This post has been revised to reflect the following correction:

Correction: December 12, 2011

An earlier version of this post gave an incorrect middle initial for the chairwoman of the Securities and Exchange Commission. It is Mary L. Schapiro, not S.

Article source: http://feeds.nytimes.com/click.phdo?i=762f38127d1f3f3ea3e7689ed708e67c

DealBook: Bank of America Profit Drops 37%

Bank of America reported a 37 percent drop in first-quarter earnings on Friday, as the nation’s biggest bank continued to battle the legacy of the mortgage crisis and legal problems linked to the ill-fated acquisition of Countrywide Financial.

Although Bank of America’s loan portfolio showed some improvement in recent months, the bank lost $2.4 billion in its consumer real estate group, compared with a $2 billion loss the previous year. The poor results in home lending were partially offset by a $2.2 billion release of reserves and strong earnings from the bank’s credit card business.

After another disappointing quarter, the bank decided to shake up its management team on Friday and create a new position focused on legal and regulatory problems.

Bank of America, facing a prolonged reckoning in its mortgage business, has yet to shake the wide-ranging legal woes surrounding Countrywide, the former subprime lending giant. The bank put aside another $1 billion in the first quarter to cover claims from scorned investors who want the firm to repurchase billions of dollars in bad Countrywide mortgages. The bank also reported a spike in repurchase requests from Fannie Mae and Freddie Mac, the government controlled mortgage companies that already received some $3 billion from the bank last year.

The bank did take a step toward resolving complaints from mortgage-bond insurers, announcing on Friday a $1.6 billion agreement with Assured Guaranty, which guaranteed several mortgage-bond deals backed by Countrywide loans.

Bank of America in the first quarter also recorded some bright spots on its balance sheet. The bank’s credit card business saw income rise by 77 percent to $1.7 billion. Commercial banking reported a profit of $923 million, compared with $703 million in the same period of 2010. The investment banking operation reported strong results, as well, on the back of improved sales and trading revenue.

With overall earnings of $2 billion, or 17 cents a share, the bank still missed analysts’ estimates of 27 cents a share. Bank of America earned $3.2 billion, or 28 cents a share, in the same period a year earlier.

Total revenue dropped, too, to $27 billion from $32 billion, a decline partly attributable to the weak economic recovery. As consumers cling to their cash amid uncertain times, mortgage lending has stalled at Bank of America and other giant lenders. The bank, facing new government regulations, also missed out on millions of dollars in overdraft fees and other charges once levied on consumers.

The bank’s shares were down more than 1 percent in Friday morning trading.

Still, the quarterly profit can be seen as an encouraging sign for the bank after it recorded two straight quarterly losses totaling $8.5 billion.

“Strong growth in deposit balances and positive contributions from five of our six businesses reflect the steady improvement in the broader economy,” the bank’s chief executive, Brian T. Moynihan, said in a statement. “Our customer-focused strategy is working well, and we also benefited from improved credit quality.”

Bank of America is the second big financial firm to unveil first-quarter figures this week. JPMorgan Chase reported a record $5.6 billion quarterly profit on Wednesday, with the bank facing similar problems in its home lending unit. Other industry giants like Citigroup, Goldman Sachs and Wells Fargo are set to report earnings next week.

Bank of America’s report comes at a crucial time for the company, which is hoping regulators will approve a plan to increase the bank’s token 1 cent dividend. In March, the Federal Reserve nixed the bank’s proposal to raise its shareholder payouts in the second half of 2011. The bank said on Friday that it would try again, although it would not say when and analysts are skeptical of its chances.

“I think, eventually, the bank will have to back off,” said Marty Mosby, an analyst at Guggenheim Securities, a brokerage firm.

As the bank seeks to shed the legacy of the financial crisis, a nagging problem stands in the way: Countrywide. Bank of America bought the subprime lender for $4 billion, or roughly $4.25 a share, in July 2008.

Now, Countrywide has opened the bank’s giant mortgage business to attacks on multiple fronts.

Institutional investors want Bank of America to repurchase billions of dollars in soured mortgage securities sold by Countrywide at the height of the crisis.

The biggest spike came from Fannie Mae and Freddie Mac, the government-run firms that squeezed some $3 billion from the bank last year to cover claims that Countrywide’s underlying mortgages did not meet underwriting standards.

That settlement apparently did not satisfy Fannie and Freddie, whose outstanding claims recently rose to $5.3 billion, up from $2.8 billion in the fourth quarter of 2010 — reflecting “new claims” that were “not covered” by the previous agreements, the company said.

As a result, the bank’s potential hit on the claims increased, too. Bank of America’s liability increased by $800 million in the first quarter, bringing the total amount to $6.2 billion. That’s up from $3.3 billion in the same period of 2010.

The bank has previously said it could spend anywhere from $7 billion to $10 billion buying back troubled loans.

Bank of America also is among several firms ensnared in state and federal investigations into fraudulent foreclosure practices. The bank and 13 other firms signed an agreement with federal banking regulators on Wednesday to overhaul their foreclosure operations and adopt new oversight procedures.

But the bank and its peers still face demands from state attorneys general to make additional concessions and approve a multibillion-dollar settlement. The various investigations “could result in material fines, penalties, equitable remedies (including requiring default servicing or other process changes), or other enforcement actions, and result in significant legal costs,” Bank of America said in its 2010 annual report.

JPMorgan and other Wall Street titans face similar liabilities, although Bank of America’s mortgage woes set it apart. The bank, for instance, compared with its competitors, has many more loans on its books that have soured, according to a recent report by Oppenheimer Company. It also is unclear just how much legal liability the bank ultimately will face, an uncertainty that continues to plague its bottom line.

“With Bank of America, you’ve got this special asterisk: There’s no precedent to judge their exposure,” said Chris Kotowski, an analyst at Oppenheimer. “If not for that, I would be recommending the stock.”

Bank of America announced on Friday that it hired Gary Lynch, formerly of Morgan Stanley, to be its first chief of legal, compliance, and regulatory relations. The bank also said that its chief financial officer, Charles Noski, will leave his post after only a year to tend to “a serious illness of a close family member.” Mr. Noski, who will be replaced by the bank’s current chief risk officer, will remain at the company as vice chairman.

The bank last quarter had some trouble generating new loans, as revenue decreased to $2.2 billion this year from $3.6 billion in the first quarter of 2010. JPMorgan’s loan numbers were down, too, as banks tightened their underwriting standards and consumer tightened their belts.

“While loan growth tends to be seasonally weak in the first quarter, this quarter is tracking worse than seasonality would suggest,” a Barclays Capital analyst, Jason Goldberg, said in a recent report.

In the face of its mortgage woes, the bank did report some encouraging news about its loan portfolio. The bank’s net charge-offs for the quarter came in at $6 billion, compared with $10.8 billion a year ago. There was also a modest drop in nonperforming loans, which fell 14 percent to $31.6 billion.

The bank’s merger with Merrill Lynch, another marriage forged amid the financial crisis, has fared far better than its takeover of Countrywide. The global wealth management group, which includes Merrill, reported record revenue of $4.5 billion, versus $4 billion a year ago. Earnings rose more than 22 percent.

“There’s a nice feel to how Merrill is coming in,” Mr. Mosby said.

Article source: http://dealbook.nytimes.com/2011/04/15/bank-of-america-profit-drops-nearly-36/?partner=rss&emc=rss