Too Big To Jail Revisited
Last January Frontline broadcast a documentary entitled “Too Big To Jail” detailing the Justice Department’s failure to bring criminal charges against the biggest players in the credit crisis. In the last week we’ve gotten a stark reminder that too big to jail is still alive. JP Morgan settled the London Whale case with the SEC and other regulators by paying $920 million in fines and admitting that it had poor internal controls. The Commodities Futures Trading Commission continues to pursue charges against JP Morgan for market manipulation. The Justice Department brought charges against two traders last August and still has an open investigation.
While the settlement amount of $920 million is significant in comparison to the overall loss of $6 billion, JP Morgan’s admission isn’t very significant. In 2012, when the trading impropriety first surfaced, JP Morgan had to restate its first quarter financials, which was a tacit admission that its internal financial controls were flawed. Will higher ups at JP Morgan be indicted? I doubt it. It’s easy to rail against the Justice Department for its poor record of bringing indictments against the high and mighty at the big Wall Street banks. However, as I’ve looked back I’ve come to recognize the impenetrability of the banks’ defenses.
Senior executives at major financial institutions are well insulated from criminal charges. In fact, there are several layers of protection. Because these organizations are so vast and have complex reporting lines, it is exceedingly difficult to reach the requisite level of proof to show that senior executives had direct knowledge and involvement in any particular impropriety. Thus, it’s much easier to trace Raj Rajaratnam’s insider trading as the CIO and founder of the Galleon hedge fund than tracing Richard Fuld’s involvement in Lehman’s demise. Galleon was a tiny organization. Lehman was a byzantine empire.
The big banks don’t just rely on complexity. They use the revolving door to hire key people from the regulatory agencies. For example, the general counsel for JP Morgan is none other than Stephen M. Cutler, former head of enforcement for the SEC. The major Wall Street firms all have their fair share of well-connected Washington alums.
If the regulatory authorities or the US District Attorney decides to pursue the big banks, the major law firms are well stocked with an additional layer of defense. The top lawyers are available to represent both the corporation and key executives. For example, this summer Robert S. Khuzami, the former head of the Enforcement Division, joined Kirkland & Ellis, a leading securities law firm. I’m sure Mr. Khuzami already has a roster of firms that are too big to jail. When my former employer, Legg Mason, had a regulatory problem with its high yield mutual fund, we retained a former senior SEC enforcement official who had just departed the SEC to join a major Washington law firm. The goal was to protect higher ups in the organization from a potential charge of “failing to supervise.”
The big banks add raw political influence on top of organizational complexity and a bevy of former regulators. It doesn’t matter if the current administration is Republican or Democratic, the big Wall Street firms have more than enough financial clout to bend the politicians to their will. Yesterday I posted the link to a story about Richard M. Bowen, a whistleblower who worked at Citigroup. Mr. Bowen’s saga is a great illustration of the power of political influence.
Dodd-Frank did little to prevent the next financial crisis. In fact, the new law solidified the position of the big Wall Street firms. The big firms have only gotten larger and more complex. Our continued adherence to “too big to fail” ensures that “too big to jail” will persist.
PS: Andrew Ross Sorkin writes in The New York Times this morning that JP Morgan’s shareholders are double victims in the case. First they suffered the financial impact of the trading loss and then their money funded the penalty. In my view, the shareholders have been complicit because they’ve failed to standup to management or the board. In fact, investors idolized Chairman Jamie Dimon and have gotten what they deserve.