After Financial Crisis, Prosecutors Navigate Tricky Waters

The question of whether large financial institutions can ever be held fully responsible for criminal conduct has again become a political controversy.

Attorney General Eric H. Holder Jr. responded to a question at a Senate Judiciary Committee hearing last week about the failure to prosecute multinational banks for various transgressions by saying, “I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if we do prosecute – if we do bring a criminal charge – it will have a negative impact on the national economy, perhaps even the world economy.”

Mr. Holder’s frank admission that the Justice Department’s hands are sometimes tied in responding to corporate wrongdoing was offered in the context of a larger discussion about how companies that are considered “too big to fail” have become effectively insulated from facing criminal charges. But the attorney general shifted the focus back to Congress when he went on to say, “I think that’s something that we — you all — need to consider.”

Despite the finger-pointing, the fact remains that few executives have been held responsible when their company engages in misconduct.

Various officials have their own explanation for the lack of action. At another Senate hearing last week, Jerome H. Powell, a member of the Board of Governors of the Federal Reserve, said that the decision to not file criminal charges against HSBC over money laundering was not attributable to the regulators, who can only pursue civil remedies. Instead, he pointedly said that “the Justice Department has total authority” on deciding “who gets prosecuted for what.”

Others have attributed the lack of prosecutions to the so-called Arthur Andersen effect, named because of the demise of the accounting firm after it was convicted of obstruction of justice related to its auditing work at Enron. After the firm was found guilty and was forced out of business, thousands of jobs were lost, sending a chilling message to prosecutors that they needed to tread carefully when pursuing criminal charges against a company in a highly regulated industry.

Despite the fear of charging a large bank with a crime, the Justice Department has tried to show its mettle recently in cases involving manipulation of the London interbank offered rate, or Libor. Its solution to the problem has involved having foreign subsidiaries of global banks plead guilty to a charge, rather than the whole entity.

As I noted in a previous post about how banks would have to settle these cases, this type of resolution is intended to limit the impact on the parent bank because the entity admitting guilt has no operations in the United States, so there a few collateral consequences from the conviction.

But the fear of putting a large company out business – even if a legitimate concern in some instances – does not mean that individuals should also avoid prosecution for their role in corporate misconduct. At the Senate Banking committee hearing, David S. Cohen, the Treasury undersecretary, acknowledged that regulators had not aggressively pursued individuals “who are responsible for the conduct that has resulted in fines and penalties against the institution itself.”

Although a few lower-level traders have been charged, the settlements involving large banks over manipulation of Libor have not involved any real costs to senior executives. And HSBC’s money laundering case involved neither a corporate guilty plea nor any direct action against individuals responsible for long-running practices.

Of course, pursuing cases against individuals is often easier said than done. For a criminal charge to stick, the government must prove the requisite intent beyond a reasonable doubt, which allows for defenses like ignorance or good faith to be used. The government has won some convictions in banking cases, like one against the former mortgage executive Lee B. Farkas, who received a 30-year prison sentence. But those cases have been few, with none filed recently.

Trying to assess civil penalties against individuals involved in money laundering cases like HSBC’s would not necessarily be easy, either. The statute authorizing the sanctions requires proof that the bank official acted “willfully.” In Ratzlaf v. United States, the Supreme Court interpreted that term in a case involving currency reporting to require proof that the defendant intended to violate a known legal duty, a very high standard.

The banking law also authorizes civil penalties for negligent violations, a much lower threshold of proof, but those can only be sought from a financial institution, not individuals. The amount of any assessment is limited to $500 for a violation, or $50,000 for a pattern, which is not much of a deterrent against a multinational bank.

The government has also stumbled in its handling of other civil cases. For instance, the Securities and Exchange Commission lost its case against a midlevel executive at Citigroup for his role in the sale of a collateralized debt obligation tied to subprime mortgages, even though the agency only needed to prove negligence.

S.E.C. charges against mutual fund executives for making misleading statements about the stability of a money market fund during the height of the financial crisis resulted in a finding against only one individual, and then just for negligence and not intentional fraud. The agency is appealing that verdict, but winning the case will be difficult.

Mr. Holder is certainly right when he said that the impact of a prosecution needs to be considered before charges are filed, and a repeat of the demise of a firm like Arthur Andersen is not something to be taken lightly. But the real frustration is the lack of individual prosecutions, which strengthens the impression that the company will take the hit by paying a large fine to protect executives.

Whether a bank is “too big to jail” is not relevant to determining how to hold individuals accountable for corporate misconduct. Congress may want to consider measures to authorize regulators to hold corporate executives responsible when the company engages in misconduct if it wants to foster greater accountability.