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If The SEC Really Wanted To Get Tough On Securities Fraud It Would Have Added Some Minor Inconveniences To Its Multi-Hundred-Million-Dollar FinesBy Matt Levine
It’s clear that I am a terrible person because I continue to be unable to get all that excited about banks that commit fraud. And the big thing today is that the SEC doesn’t put banks out of business just for committing fraud, which I think is rather sporting of them but lots of people disagree.
Here’s the issue:
By granting exemptions to laws and regulations that act as a deterrent to securities fraud, the S.E.C. has let financial giants like JPMorganChase, Goldman Sachs and Bank of America continue to have advantages reserved for the most dependable companies, making it easier for them to raise money from investors, for example, and to avoid liability from lawsuits if their financial forecasts turn out to be wrong.
An analysis by The New York Times of S.E.C. investigations over the last decade found nearly 350 instances where the agency has given big Wall Street institutions and other financial companies a pass on those or other sanctions. Those instances also include waivers permitting firms to underwrite certain stock and bond sales and manage mutual fund portfolios.
JPMorganChase, for example, has settled six fraud cases in the last 13 years, including one with a $228 million settlement last summer, but it has obtained at least 22 waivers, in part by arguing that it has “a strong record of compliance with securities laws.”
Ha ha ha strong record of compliance with a fraud case every two years or so! What a sham! Except that JPMorgan actually does have a strong record of compliance, and is generally viewed as being pretty conservative and law-abiding.
This stuff stirs emotions because it’s hard to think about who is being punished here. Corporations are people, my friend (still), but in the way Mitt Romney meant it, not in the way everyone pretended to take it. Like: JPMorgan employs a lot of people, and some of them are maniacs and crooks and liars and most of them aren’t and that’s true of … the SEC, for instance, and The New York Times,* and anyone else who wants to give them shit for their fraudulosity. But JPMorgan isn’t an individual human, not any more anyway. So saying “JPMorgan is crooks” is sort of nonsensical.
So if you want to impose punishments on JPMorgan for particular fraud-y things done by particular individual humans who may or may not still be at JPMorgan you need a reason. There are two candidates. The first is that the securities laws are the securities laws and if you’ve violated them then you’re a menace to the investing public and the SEC needs to keep an eye on you. This is what the SEC actually cares about – the Times quotes the director of Corp Fin as saying “The purpose of taking away this simplified path to capital is to protect investors, not to punish a company,” so if it doesn’t protect investors why do it. This is where Felix Salmon gets worked up:
If a company tells lies to investors, those investors should be able to sue it. And if a company wants to issue securities to the public, it’s the SEC’s job to examine the proposed offering first.
But somehow, along the way, a handful of very big companies — especially banks — managed to persuade the SEC that they were trustworthy corporate citizens, and that they didn’t need to be bound by those rules.
That’s a little bit suspicious just for starters. But it gets much worse. The SEC, quite naturally, put in place a policy which said that if any of those companies ended up being fined by the SEC for violation of securities laws, then it would lose its special privileges.
And then the SEC proceeded to ignore that policy.
That’s, like – none of that is exactly false but it’s not quite right either. Let’s spend a minute on what these “waivers” actually are. We’ll start really really slow. There is a thing called the SEC. It has rules about how you can offer securities. Those rules are quaint and amusing, designed in the 1930s to prevent people from just making shit up, writing it down and selling it to people. Part of why they look quaint now is that they basically worked. These days you can have Ponzi schemes that fall outside of the public-company securities laws, and you can have Enron-y companies where the companies are very craftily hiding their inventions from their auditors, but you can’t just write numbers on a piece of paper and raise large quantities of public capital without someone noticing. Except if you’re in China.
One of those rules is that the SEC needs to review your filing before you issue securities. Very sensible when you’re a newly public company and you report net income excluding the effect of expenses, but less so when you’re a longstanding public company whose periodic filings are subject to SEC review. So the SEC allows “well-known seasoned issuers” to issue when they feel like it, rather than waiting weeks or months for SEC review. This works well because (1) no one is reading the historical financials in the new-issue prospectus; they’re reading the historical financials that have already been disclosed, and (2) the SEC is not, like, reviewing your deals to make sure that they’re good deals or that you’re not lying, they’re just reviewing to see that you’ve followed the normal forms of accounting and been signed off on by your auditors etc. So if you’re regularly having reliable auditors sign off on your financials, having the SEC sit on any offering for two weeks double-checking that is unlikely to help investors.
Another rule is that you can’t lie in your securities offerings. That is PRETTY PRETTY OBVIOUSLY a good idea but it depends on what you mean by “lie.” If you say “we sold 100 widgets last year” and you actually sold zero, bad. If you say “we think we’ll sell 200 widgets next year if all goes according to plan,” and there’s an earthquake and you sell no widgets – should you be sued for that? No, says the SEC, so long as you appropriately caveat things.**
Now those protections – the “well-known seasoned issuer” fast track and the “forward looking statements” safe harbor – come from relatively recent legislation designed to modernize the securities markets. And you lose them – and are back in the old rules of “the SEC reviews everything and you get sued for everything that goes wrong” – if you, like, already committed fraud in the last three years. But the SEC can waive those penalties, and they have, and maybe that’s bad. But I don’t think you can rationally look at the army of internal accounting policy people at JPMorgan, and the army of bankers and lawyers who write JPMorgan’s disclosure for its own fundraising, and say that just because an entirely separate army of people who wrote the entirely separate disclosure for its, say, CDO deals, “committed fraud,” then the first army are just a bunch of scammers.
Or, hell, maybe you can – maybe there’s a “culture of fraud” at JPMorgan, and every other bank, and so they should all be on double secret probation – but you still can’t come to the conclusion that an SEC review of the format of their filings would protect investors, or that their forward-looking statements should be extra sue-able, because the SEC isn’t looking for fraud in its review of filings, and the forward-looking statements were never the problem. The SEC knows this – again from the Times:
The agency usually revokes the privileges when a case involves false or misleading statements about a company’s own business.*** It does not do so when the commission has charged a Wall Street firm with lying about, say, a specific mortgage security that it created and is selling to investors, a charge Goldman Sachs settled in 2010. Different parts of the company — corporate officers versus a sales force, for example — are responsible for different types of statements, officials say.
Of course, even if the sanctions don’t actually protect investors after the fact, you might want to impose them anyway because they are a “deterrent” and if you don’t impose them then banks will just go around committing fraud all the time and get away scot-free except for the multi-hundred-million-dollar fines. Again, making J. Pierrepont Morgan wait three weeks to do a debt deal**** and expose him to liability on forward-looking statements might be enough to scare him straight. If he were a human who was both concocting CDO fraud and responsible for corporate filings. But here is a conversation that has never happened:
Compliance officer: It’s very important that you don’t commit fraud.
Banker: Please elaborate.
CO: If you commit fraud, we could be fined hundreds of millions of dollars and you may be personally fired, fined, or imprisoned.
B: Hmm. I can live with that. Fraud it is.
CO: Also we will lose WKSI status and have to undergo SEC review of shelf registration statements, as well as losing access to the PSLRA safe harbor for forward-looking statements.
B: Oh, wow, that’s serious. Okay I’ll be good.
The non-waiver of these sanctions is not even a possible deterrent for CDO fraud because there is no overlap between the people who care about them and the people who need deterring.
The subtext of all of this is that the SEC is weighing the balance between protecting the integrity of the capital markets, on the one hand, by being tough on pseudo-crime like CDO fraud, and preserving the existence of the capital markets, on the other hand, by allowing giant and systemically important banks efficient access to funding. There is probably a structural worry there. Maybe Jamie Dimon is so important to the functioning of our interconnected financial system that if he killed a man the government would have to let him go so he could keep clearing trades. And that seems like a problem. If some banks are too important to punish then they’re probably too big to succeed™.
But that’s hardly a reason for the SEC to make particular enforcement decisions. And it’s not a reason to get worked up about the fact that they let the biggest users of the modern financing markets continue to have access to the modernized rules governing those markets even if, in some of their businesses, they push up awkwardly against some entirely different rules.
* See? Mistakes happen even in the finest organizations.
** The appropriate caveats usually go in a “forward looking statements” disclaimer at the front or back of every press release, filing and investor presentation. Those are usually boilerplate that no one reads but today a reader sent us a – surprisingly fun! – E&P investor deck today that starts like so:
That is how it’s done.
*** TBF Yves Smith points out that BofA’s maybe lying about the Merrill bonuses didn’t get it penalized.
**** It’s also worth saying that Citi did actually get slapped with the no-WKSI-for-three-years sanction and survived, in part because under modern shelf takedown rules not being a WKSI doesn’t really prevent you from doing securities offerings at your leisure, as long as you first file a reviewed shelf, which Citi did and it was fine.