The Prosecution That Isn’t Happening

People keep asking why no senior executive has gone to jail for the misdeeds that produced the financial crisis—and cost the United States more than $6 trillion, or $50,000 per household, in lost economic output. The usual answers are that no one did anything wrong (oh, come on) or, more realistically, that it’s too hard to convict individuals in complex financial fraud cases.

At the same time, however, the U.S. Attorney’s office for the Southern District of New York—the district that includes Wall Street—has amassed a 79-0 record in insider trading cases, including yesterday’s jury verdict against Mathew Martoma, a trader at the hedge fund firm SAC Capital Advisors. In Martoma’s case, he obtained confidential information about a clinical trial for a drug being manufactured by two pharmaceutical companies and, according to the jury, convinced his boss, Steven Cohen, to unload the firm’s positions in those two stocks.

Now, despite the 79-0 record (which includes guilty pleas), insider trading is not necessarily the easiest thing in the world to prove, especially in a criminal action. Insider trading is a violation of SEC Rule 10b-5 (see the Martoma indictment), which requires the prosecution to prove a series of elements, including scienter—that the defendant knew he was doing something wrong—beyond a reasonable doubt. Proving that something was going on inside someone’s head is tough, but it can be done.

Now guess what? Rule 10b-5 is also one of the ways to go after someone for the kind of securities fraud that helped produce the financial crisis. The SEC’s successful civil action against “Fabulous” Fabrice Tourre of Goldman Sachs, for defrauding investors in an ABACUS collateralized debt obligation, was also predicated on violations of Rule 10b-5 (and Section 17(a) of the Securities Act of 1933, which is similar). Yet while the Southern District has convicted 79 people of insider trading, when it comes to engineering the financial crisis, only two people have gone down—Tourre and Countrywide’s Rebecca Mairone—and they were both found liable on civil, not criminal charges. (And in Mairone’s case, the prosecution had to rely on special statutes covering fraud committed against government agencies.)

You might say that Mathew Martoma is no senior executive, and you would be right. As one witness said, Martoma was only a “grain of sand” next to Steven Cohen, the head of SAC Capital Advisors and the man the Southern District and the FBI really wanted to nail. But the SEC is going after Cohen, too, on civil charges of negligent supervision. That is, with eight SAC employees having been convicted of insider trading, the claim is that even if Cohen didn’t know what was going on (as of yet, the SEC seems to think they don’t have enough evidence to make that stick), he must have been negligent in supervising his firm’s portfolio managers.

So why isn’t anyone going after Lloyd Blankfein, Angelo Mozilo (for something other than dumping his own Countrywide stock), Jamie Dimon, or any of the other CEOs who, at best, were unaware that their lieutenants and foot soldiers were ripping off their clients? It’s true that negligent supervision is a specific type of liability that applies to investment advisors (although any big bank these days includes dozens of investment advisory firms within its umbrella), but it’s hard to imagine that an imaginative prosecutor couldn’t come up with another source of liability. Tourre, for example, was found liable for aiding and abetting wrongdoing committed by Goldman Sachs. Whom, then, was he aiding and abetting?

Sure, insider trading is a bad thing, but in the grand scheme of things it’s peanuts compared to the financial crisis and the behavior that produced it. The SEC likes to talk about maintaining “confidence in the markets” among ordinary investors, and people like Mathew Martoma certainly don’t help, but there are other, bigger things to worry about: the legal insider trading that corporate executives do routinely under cover of 10b5-1 plans, for one thing, or the prospect of a technological meltdown in the markets, for another.

It’s easy enough to come up with sinister theories for why the powers that be seem more interested in pursuing insider trading cases than financial crisis cases, which I won’t bother mentioning. There are less sinister theories as well. Maybe, five years after the financial crisis, it’s easier to tell a story about a rich hedge fund manager cheating (Martoma “bought the answer sheet,” U.S. Attorney Preet Bharara said) than about a less-rich investment banker misleading his even-less-rich buy-side clients investing their not-rich-at-all customers’ pension funds.

But that’s not the way the laws should be applied. Ideally, they should be applied fairly. We know that in a world of scarce resources it’s not possible to hold every wrongdoer accountable. Failing that, however, we should punish the people who do the most harm and deter the kinds of misbehavior that will cause the most harm in the future. It’s hard to think of something that caused more harm than the financial crisis. But the heavy artillery of our legal system are looking elsewhere.