Bad Actors, Good Action

Addressing the collateral consequences of punishment has long bedeviled the Solomons of justice. The poorly behaving student is expelled, but then is denied access to alternative schooling. Washington metes out penalties for financial misdeeds, but concern for those collateral consequences has in many cases led to light punishment.

The U.S. Department of Justice’s Attorney General Eric Holder confided that HSBC Bank USA, found guilty of laundering $200 trillion worth of money for tyrants, terrorists and narco-traffickers, was so large that holding it fully accountable might jeopardize the economy. The reasoning is similar to that used justify bailing out the “too big to fail” banks that caused the economic collapse. This led to the epithet: too big to jail (TBTJ.)

The TBTJ problem has infected other regulators. Corporate violations announced by the Department of Justice are supposed to trigger mandatory penalties when the same entity is overseen by other agencies, such as the Securities and Exchange Commission (SEC). For example, the SEC deems financial firms that break the law “bad actors,” which disqualifies them from certain activities.

One disqualification prevents financial firms from selling private securities for clients companies. These private securities are sold to larger, more sophisticated investors. Qualifying private securities offerings receive less SEC scrutiny than offerings to the general public. Excluding bad actors from selling these securities serves two purposes: It protects investors from scheming sales firms, and it acts as a deterrent to the violation of laws.

Until last year, however, the SEC routinely waived these mandatory penalties when wayward firms appealed them. Then, newly appointed SEC Commissioner Kara Stein joined with veteran Commissioner Luis Aguilar to question these routine waivers. Standing up for investors, she began with the case of the Royal Bank of Scotland, which was criminally convicted of manipulating interest rates. Stein dissented from bank’s request for a waiver, explaining that she “fear[ed]” that the commission “may have enshrined a new policy — that some firms are just too big to bar.” In this vote and a series of waiver requests after this, Democrat Chair Mary Jo White joined with the two Republican commissioners and approved the waivers. Stein and Aguilar lost the votes, 3-2.

Then came the Bank of America (BoA) case. The Department of Justice (DOJ) found that the Charlotte, N.C.-headquartered mega-bank committed massive fraud by knowingly packaging mortgages of borrowers who couldn’t pay into securities that were doomed to failure. This DOJ case triggered several mandatory penalties at the SEC. As a bad actor, BoA could no longer freely sell certain types of private securities. In this case, however, Chair White could not again vote with the Republicans and grant a waiver; she’d served as counsel to the former BoA CEO, and recused herself from the case.

Deadlocked, the remaining four SEC commissioners worked on a new resolution for bad actors. On Nov. 25, they adopted a four-page settlement. Essentially, they put BoA on probation. They ordered it to retain an independent consultant ”not unacceptable” to the SEC to review BoA’s private securities offerings. The consultant must report BoA’s activities including any “potential non-compliance.” The probation enshrined in the SEC settlement agreement ends in 30 months, but then BoA loses its privilege to sell these private securities unless it can convince the SEC to grant it a waiver.

In a December speech, Stein described the BoA settlement as a “breakthrough.” With fraud so rampant on Wall Street that figures such as New York Federal Reserve Bank President William Dudley consider it part of the “culture,” Stein rallied her fellow regulators to stiffen their resolve. “We can’t afford to ignore what may be one of our most effective methods of improving compliance with the securities laws. “

Unfortunately, there will be other bad actors for the SEC to review. And Chair White will likely vote on them. But the BoA settlement will serve as precedent. It won the support of all four commissioners, including the two Republicans. Chair White should respect that precedent and not undermine it with a soft response for future bad actors. A nation still recovering from macro-economic financial frauds, or suffering from the drug trafficking enabled by money-laundering banks, deserves no less.

Bartlett Naylor is the financial policy advocate for Public Citizen’s Congress Watch division.

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