The Securities and Exchange Commission’s (“SEC”) mission is
“to protect investors, maintain fair, orderly, and efficient
markets, and facilitate capital formation.” The SEC believes
that its “investor protection mission is more compelling than ever”
since more first-time investors have turned to the market to invest
in their future. Therefore, it goes without saying that the
SEC’s enforcement authority is crucial in maintaining investor
protection. But, has the SEC stepped up to the plate
considering the negative impact the 2008 financial crisis has had on
investors?
The 2008 financial crisis had devastating effects on our economy
which caused massive job losses and a growing number of American
families at risk of foreclosure and poverty. However, some
companies made substantial profits from the financial collapse and
many top executives received considerable bonuses (some from
government bailout money) after millions of families’ investments
dwindled or even disappeared.
Most recently, the SEC filed civil fraud charges in Texas against
former Chief Executive Anthony Nocella and former Chief Financial
Officer J. Russell McCann of Franklin Bank Corp. for concealing the
deterioration of the bank’s finances during the mortgage crisis.
Specifically, the SEC alleged that in 2007, Nocella and Man used
aggressive loan modification programs to hide the bank’s
non-performing loans and artificially boost profits. See
SEC
Complaint.
Despite having charged over 100 people and firms with fraud tied
to the financial crisis, critics of the SEC believe the agency hasn’t
buckled down hard enough. Yet SEC enforcement chief, Robert
Khuzami, believe these numbers show the agencies effectiveness in
“tackling financial-crisis wrong-doing.” Of the 74 cases
filed against individuals, 55 are chief executives, finance chiefs or
other top officers. Khuzami believes this “sends a strong
deterrent message.”
Many of the SEC critics note that about 24 of the people charged
by the SEC have avoided trial by reaching “weak” settlements.
Senator Grassley from Iowa stated, “The lack of accountability from
Wall Street encourages recidivism.”
For instance, Angelo Mozilo, Chief Executive of Countrywide
Financial Corp., agreed to a settlement of $67.5 million ($22.5
million penalty and $45 million disgorgement), while denying any
wrongdoing. These sanctions are supposed to compensate
investors for their losses. However, the repayment of illegal profits is
tax-deductible and can be covered by some corporate insurance
policies. In Mozilo’s case, nearly half of the $45 million
payment came from Countrywide's current owner,
Bank
of America Corp. It can be difficult for the SEC to
challenge indemnification rights in employment contracts or insurance
policies.
According to The Wall Street Journal, in the 24 crisis-related
cases where the SEC reached a settlement with an individual, the
median sanction was $203,751. These same defendants paid a
combined $80.7 million in penalties. Most of those penalties
came from executives at collapsed mortgage lenders such Countrywide,
American Home Mortgage Investment Corp. and New Century Financial
Corp.; yet, their investors sustained losses of about $31 billion
based on the three companies' peak stock-market value before the
financial crisis began. These penalties arguably pale in
comparison to investor losses.
Even some federal judges have criticized the large gaps between
investor losses and the penalty. For example, U.S. District
Judge Frederic Block in New York, said $1.05 million in penalties
paid by two former Bear Stearns Cos. hedge-fund managers, Ralph
Cioffi and Matthew Tannin, in a proposed settlement of civil-fraud
charges against them was “chump change” compared with the $1.8
billion lost by investors. The judge has not yet approved the
proposed settlement.
While to some, the above penalties may seem like an inadequate punishment
for the charges, Cioffi and Tannin have agreed to a temporary
ban from the securities industry. Khuzami believes the SEC’s
power to expel people from the securities industry or from serving as
directors of public companies is “probably one of the most powerful
sanctions [it has].”
Furthermore, when reaching settlements, the SEC has to weigh the
likelihood of losing to a jury, along with the amount the agency can
show was a
direct result of the wrongdoing. In some
cases, it can be hard to say with certainty how much of investor
losses were caused by fraud or illegal conduct, or if any fraud or
illegal conduct actually took place. Usually, defendants argue
the financial losses were due to a failure to predict the meltdown,
rather than any fraud on their part. The answer is not always
clear cut and pushing for stricter penalties across the board may not
be appropriate for each case.
Nevertheless, we can only hope that Americans’ trust in our
banking and financial systems can once again be restored.
