Probably the most interesting question in white-collar crime these days is why there were no prosecutions arising out of the financial meltdown a few years ago.

As with most interesting questions, there are two polarized sides — one side wants to take up pitchforks and torches and head to Wall Street now, and the other side thinks that perhaps we should be a bit more circumspect about throwing people in prison (from that description, you can probably guess which side I’m on).

Judge Rakoff — a man we should all listen to one almost any subject — has weighed in with a thoughtful piece in the New York Review of Books called “The Financial Crisis: Why Have No High-Level Executives Been Prosecuted?

How does Judge Rakoff answer the question?

First, he states the obvious — if there’s no fraud, there should be no prosecution.

[I]f the recession was due, at worst, to a lack of caution . . . then the criminal law has no role to play in the aftermath. For in all but a few circumstances (not here relevant), the fierce and fiery weapon called criminal prosecution is directed at intentional misconduct, and nothing less. If the Great Recession was in no part the handiwork of intentionally fraudulent practices by high-level executives, then to prosecute such executives criminally would be “scapegoating” of the most shallow and despicable kind.

And, has that kind of intentional misconduct taken place? We don’t know, and Rakoff says he has no opinion.

But, he thinks, there’s good reason to be suspicious. Assuming that’s right, Rakoff goes through why it would be so, in light of his excellent vantage point about the institutional issues that drive white-collar prosecutions.

As an aside, before we get started on Rakoff’s discussion, let me point out that there have been mortgage fraud prosecutions since the meltdown. Many of them are local, though, where U.S. Attorney’s Offices are going after lower level players in the mortgage business, rather than executives at companies involved in mortgage fraud. If you’re curious, there have been prosecutions in Tampa, of reality TV stars, and of ultramarathoners who trigger weird schadenfreude in IRS agents.

Back to Rakoff. Why no prosecutions in the C-suite? The Judge rejects a few possible explanations that have been offered by DOJ. According to Rakoff, the problem isn’t that executives likely didn’t know what was going on, it doesn’t lie with the difficulty in proving that sophisticated counter-parties relied on any false statements, and it isn’t really accounted for by a concern that such prosecutions would harm the economy (as Holder may or may not have said).

Rakoff’s project isn’t really in justifying the lack of prosecutions (assuming fraud happened, which he only does for the purposes of this article). Rather, he’s trying to explain why the system is set up to get this result. He’s doing sociology not policy work here.

He rejects the fastest sociological explanation offered by the haters of Wall Street — that AUSAs want to cut financial executives a break because they see the law firm partnership looming:

At the outset, however, let me say that I completely discount the argument sometimes made that no such prosecutions have been brought because the top prosecutors were often people who previously represented the financial institutions in question and/or were people who expected to be representing such institutions in the future: the so-called “revolving door.” In my experience, most federal prosecutors, at every level, are seeking to make a name for themselves, and the best way to do that is by prosecuting some high-level person. While companies that are indicted almost always settle, individual defendants whose careers are at stake will often go to trial. And if the government wins such a trial, as it usually does, the prosecutor’s reputation is made. My point is that whatever small influence the “revolving door” may have in discouraging certain white-collar prosecutions is more than offset, at least in the case of prosecuting high-level individuals, by the career-making benefits such prosecutions confer on the successful prosecutor.

I think he’s right — and that’s creepy in lots of other cases — but I don’t think anyone who is anything like on the inside of this business thinks that an AUSA doesn’t want to bring a big case.

Rather, Rakoff said there are three factors that led to the lack of prosecutions.

First, government budgets and priorities led to a gap right when the lack of a gap was necessary to investigate these cases. The FBI shifted resources after 9/11 from financial crimes to terrorism, and Rakoff thinks little of the SEC’s priorities or budget of late. They’ve been going after low-hanging fruit too — just like the U.S. Attorney’s Offices.

Worse, the financial fraud investigations were farmed out to a number of US Attorneys Offices, rather than keeping them all in New York. That leads to what you see in Tampa, and not to a prosecution in a boardroom.

And the fabled U.S. Attorney’s Office in S.D.N.Y. was busy doing insider trading cases.

As Rakoff says,

While I want to stress again that I have no inside information, as a former chief of that unit I would venture to guess that the cases involving the financial crisis were parceled out to assistant US attorneys who were also responsible for insider-trading cases. Which do you think an assistant would devote most of her attention to: an insider-trading case that was already nearly ready to go to indictment and that might lead to a high-visibility trial, or a financial crisis case that was just getting started, would take years to complete, and had no guarantee of even leading to an indictment? Of course, she would put her energy into the insider-trading case, and if she was lucky, it would go to trial, she would win, and, in some cases, she would then take a job with a large law firm. And in the process, the financial fraud case would get lost in the shuffle.

Second, according to Rakoff, government regulation played a big role in the conditions that set up the collapse. It’s a little awkward for the U.S. government to try to put someone in prison for implementing policies that the same U.S. government put in place.

Finally, Rakoff bemoans DOJ’s work prosecuting corporations instead of individuals. He raises reasonable concerns about prosecuting companies — those prosecutions hurt shareholders and innocent employees, they can be seen as a cost of doing business, and they lead to law enforcement policies that are odd.

And here, I think, is where the revolving door criticism starts to have merit. Check out Rakoff’s description of a corporate criminal investigation:

 Early in the investigation, you invite in counsel to the company and explain to him or her why you suspect fraud. He or she responds by assuring you that the company wants to cooperate and do the right thing, and to that end the company has hired a former assistant US attorney, now a partner at a respected law firm, to do an internal investigation. The company’s counsel asks you to defer your investigation until the company’s own internal investigation is completed, on the condition that the company will share its results with you. In order to save time and resources, you agree.

Fast forward a few months, and the benefits of this arrangement become clear.

 Six months later the company’s counsel returns, with a detailed report showing that mistakes were made but that the company is now intent on correcting them. You and the company then agree that the company will enter into a deferred prosecution agreement that couples some immediate fines with the imposition of expensive but internal prophylactic measures. For all practical purposes the case is now over. You are happy because you believe that you have helped prevent future crimes; the company is happy because it has avoided a devastating indictment; and perhaps the happiest of all are the executives, or former executives, who actually committed the underlying misconduct, for they are left untouched.

Judge Rakoff is a wicked smart guy who has been around this block. I think there’s a lot for everyone with a strong view of what should have happened to be disappointed with in his piece.

Earlier: Judge Rakoff Rips The Government For Dropping The Ball On Financial Crimes


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