Louis Lanzano/Associated PressBruce Bent, right, and his son were cleared in October of of defrauding investors in their mutual fund. Bruce Bent II was found negligent in his statements to investors.Last week was a study in contrasts in how the Securities and Exchange Commission has been able to pursue cases from the financial crisis. The regulator has been successful in extracting large settlements from banks that were are the heart of the meltdown in the mortgage market, but it has not done as well in proving any significant wrongdoing by individuals.
That raises the issue of why the agency has been able to pursue the large institutions but does not bring cases against senior managers overseeing those companies for violations of the federal securities laws. The problem is that proving an individual broke the law is much more difficult because juries seem to find it much easier to put the blame on the organization while exonerating those who work there.
The S.E.C. announced settlements on Friday with JPMorgan Chase and Credit Suisse over their dealings in residential mortgage-backed securities. JPMorgan will pay $296.9 million and Credit Suisse $120 million in disgorgement and penalties.
In addition to those cases, the S.E.C. got in on the settlement with BP last week over the Gulf of Mexico oil spill, settling securities fraud charges that the company made misleading statements about the amount of oil flowing from its well. BP agreed to pay a $525 million that will be distributed to its investors.
All told, the S.E.C. collected over $900 million that can be passed along to investors, which is not a bad haul for one week. But it had a much worse week in dealing with individuals accused of securities fraud.
On Monday, a federal jury in New York largely absolved Bruce Bent Sr. and his son, Bruce Bent II, for statements they made about the money market fund they oversaw, the Reserve Primary Fund, that collapsed at the height of the financial crisis in September 2008.
According to the S.E.C.’s allegations, the Bents misled investors in the face of substantial withdrawals because of concerns about bonds it owned from Lehman Brothers, which had just gone into bankruptcy. In the parlance of the money market industry, there was a question whether losses from Lehman would cause the fund to “break the buck” by reporting a net asset value of less than $1, something that is anathema to investors. The case focused on statements made over two days about how the Bents intended to shore up the fund’s assets to protect its net asset value, which did not come to pass and the firm stopped redemptions.
The S.E.C. accused both Bents and their investment advisory firm of violating the two primary securities fraud provisions, Section 10(b) of the Securities Exchange Act of 1934 and Section 17(a) of the Securities Act of 1933. An important difference between the two provisions is the level of intent needed for a violation: Section 10(b) requires at least recklessness, while Section 17(a) can be established by proof of only negligence.
The contrast in the jury’s verdict was striking. The advisory firm was held liable for the violations. Mr. Bent II was held responsible for being negligent in permitting the misstatements but not for acting recklessly. Mr. Bent Sr. was exonerated.
The verdict shows the split approach that juries can take to these types of cases. A company acts only through its officers and employees, so it is hard to see how the organization can commit a fraud if no individual is also responsible for the misconduct. But a jury is not required to be entirely consistent in its decisions, so it can find one defendant liable while absolving another.
That result often reflects how difficult it can be for a jury to look suspects in the eye and say that they engaged in fraud, especially when there is the option of holding a faceless organization liable. There can be a touch of King Solomon in a jury, trying to “split the baby” by avoiding a decision to impose the highest penalty on someone who claims to have acted in good faith while assuaging themselves by finding the company liable.
The challenge the S.E.C. faces in holding individuals liable for corporate misconduct came even clearer when it filed a motion to dismiss charges against Edward S. Steffelin for his role in putting together a synthetic collateralized debt obligation based on mortgage securities that was sold by JPMorgan Chase. The bank settled the case by paying $153.6 million in disgorgement and penalties in June 2011.
Mr. Steffelin did not work at the bank but at an outside firm that selected the portfolio of securities on which the C.D.O. was based. He was accused of not revealing in marketing materials the role of a hedge fund in selecting the securities. The S.E.C. only alleged that he violated Section 17(a) by acting negligently, not that he committed intentional fraud.
By dismissing the charges with prejudice, the agency effectively acknowledged that it could not prove its case despite having gathered evidence during an extensive investigation and obtaining a settlement from JPMorgan. James Stewart noted in his New York Times column on Saturday that Mr. Steffelin was “a victim of regulatory overreach.”
This is not the first time the S.E.C. has been unable to hold an individual responsible under the more forgiving negligence standard. In August, a jury exonerated a mid-level manager at Citigroup who was accused of making inadequate disclosure in the sale of a C.D.O. similar to the one Mr. Steffelin helped construct. Once again, the bank settled, agreeing to a $285 million payment, which is the subject of an appeal over whether the S.E.C. should have required it to admit wrongdoing.
If it is so difficult to hold individuals liable, why don’t the banks try to fight the S.E.C.? The case filed against Goldman Sachs in April 2010 over its sale of a C.D.O. is probably the best illustration about why it can be so costly just to have charges filed against a firm. The hit to Goldman’s reputation was much greater than the $550 million the firm eventually paid to settle the case a few months later, so firms are usually willing to settle quickly to keep the case from dragging on in public.
The result of the Primary Reserve case shows that juries are willing to hold the organization liable while largely exonerating the individuals. We live with the inconsistent verdicts of juries applying the same legal standard. The message to the S.E.C. from these cases is to tread carefully when considering whom to accuse of misconduct.