April 24, 2018
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Bankers who behave badly must be personally accountable

Adrees Latif | Reuters
Adrees Latif | Reuters
Arthur Levitt, former chairman of the United States Securities and Exchange Commission, takes part in the Reuters Global Wealth Management Summit in New York on June 5, 2013.

Five years after the world’s financial system began melting down, consumers, homeowners and taxpayers — that is, pretty much anyone who isn’t a bank executive — remain frustrated that no banking bigwigs went to jail.

The reasons are many: Specific misdeeds couldn’t be pinned on higher-ups; prosecutors got cold feet after early fraud cases resulted in acquittals; what the person on the street considered “fraud,” such as giving triple-A ratings to bonds full of shoddy mortgages, was often legal.

The popular desire to put those in charge behind bars is understandable and unlikely to abate, given last week’s arrest of a former Citigroup and UBS trader accused of manipulating interest-rate benchmarks. At the same time, prosecutors are required to prove willful intent, beyond a reasonable doubt, to violate specific laws. Almost wrecking the world economy is a very bad thing. But it is not in and of itself illegal.

So what can be done when bankers, knowing they can’t be punished for what they don’t see, purposely don blindfolds? Or when banks are caught breaking the rules but are allowed to pay large fines (which punishes shareholders, not executives) to settle civil fraud cases without admitting or denying guilt?

Those are the questions Britain’s Parliamentary Commission on Banking Standards and the Securities and Exchange Commission sought to answer last week. Their answers flow from different legal, political and cultural conventions, yet they arrive at the same correct conclusion: When banks behave badly, someone must be held accountable. A personal price must be paid for institutional misconduct.

The forensic analysis by the British commission of what ails the banking industry is a tour de force, and its conclusions and recommendations are well worth reading. One of the most dismal features that emerged from the evidence, the report states, was the absence of any personal responsibility for widespread failings and abuses.

To prevent such behavior, the commission would require banks to assign crucial responsibilities to a specific individual. Someone would be clearly identified as responsible, for, say, how Libor rates are set or managing home foreclosures. So if an enforcement action is brought against a bank, regulators would know which senior people should be held responsible.

The commission also proposes a couple of novel ideas to help regulators enforce the law. First, it would shift the burden of proof in some cases so that bankers would have to show they took positive steps to prevent wrongdoing. It also recommends a new crime of “reckless misconduct in the management of a bank.” Bankers wouldn’t have to prove they weren’t reckless. But prosecutors could build a criminal case if executives showed a pattern of willful blindness to misdeeds, for example, or emails showed they took steps to cordon themselves off from knowledge of unsavory activities.

The legal community’s immediate response: It’ll never work. How would you prove, for instance, that a man who received a knighthood for his achievements in banking was also behaving in a criminally reckless manner? One answer: Don’t be so quick to knight bankers who engage in dizzying expansions with huge amounts of borrowed money and minuscule amounts of capital.

There is a corollary. If a bank can settle a securities violation by paying a fine and without admitting to wrongdoing, it will commit the same violation over and over. This has been true through decades of SEC cases. Now Mary Jo White, the new chairman, is signaling that she will approve fewer of these kinds of settlements.

She’s right, even if the change slows down the enforcement process and increases litigation costs.

White would dial back the policy only slightly by requiring admissions of guilt when misconduct was egregious, for example, or when a large number of investors were harmed. She knows defendants won’t admit wrongdoing in cases that might open the door to shareholder suits, whose success rate would skyrocket with a guilty admission. As a result, the SEC may find itself litigating more often, with all the risks that entails. So the agency will have to choose its targets carefully.

But bankers with blindfolds and no-admit, no-deny settlements invite misconduct and allow everyone to escape responsibility. The benefits — fewer global financial crises, less severe recessions, lower unemployment — vastly outweigh the risks.

Bloomberg News (June 24)

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