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About Time: Raising Penalties for Securities Fraud -- Especially Repeat Offenders

David Callahan

People who think about breaking the law often engage in a risk-benefit analysis, looking at how big the gain is from cheating against the possible downsides of getting caught.

Too often, on Wall Street, that calculus has favored cheating: The rewards can be astronomical and the penalties can be relatively minor. Witness how many key figures in the subprime mortgage disaster -- in which investors were routinely misled about the health of such securities -- walked away with hundreds of millions of dollars in compensation and have faced no criminal charges.

Among the many reasons that the risk-benefit calculus on Wall Street favors cheating is that the SEC can only impose modest civil penalties for violations of securities law: a maximum of $150,000 per offense for individual violators and $725,000 for institutions.

Given the profits at stake on Wall Street, setting fine ceilings this low would be like making parking tickets in Manhattan only $5. It's a recipe for noncompliance and a big problem, since imposing civil penalities -- which the SEC can do without meeting the evidence requirements of a criminal conviction --  is such an important tool in super complex cases which can be hard to try in court.

So it's a welcome development that a bipartisan duo of senators, Jack Reed and Charles Grassley, have proposed legislation which would dramatically raise the maximum fines the SEC can impose, "the Stronger Enforcement of Civil Penalties Act (SEC Penalties Act) of 2012."

As explained by Reed's office:

The SEC Penalties Act increases the per violation cap applicable to the most serious securities laws violations to $1 million per violation for individuals, and $10 million per violation for entities. In cases where the penalty is tied to the amount of money gained by the bad action, the SEC would be able to triple the penalty. It would also triple the penalty cap for recidivists who have been convicted of securities fraud or subject to SEC administrative relief within the past five years. The agency would be able to assess these types of penalties in-house, and not just in federal court.

Grassley, in a statement, hit the nail on the head in decribing why the law is so important:

If a fine is just decimal dust for a Wall Street firm, that’s not a deterrent. It’s just the cost of doing business. A penalty should mean something, and it should get the recidivists’ attention.  I especially like the increased penalties for repeat offenders in this bill.  That should help change the dynamic of business as usual.

The focus on repeat offenders isn't new. President Obama called for getting tougher on repeat offenders in his State of the Union Address earlier this year, but nothing has yet come from that vow.

The problem of repeat offenders gained a lot of attention last fall, after the New York Times ran a troubling expose of how Wall Street firms have repeatedly broken the law, with few consequences. The story noted:

Nearly all of the biggest financial companies, Goldman Sachs, Morgan Stanley, JPMorgan Chase and Bank of America among them, have settled fraud cases by promising the S.E.C. that they would never again violate an antifraud law, only to do it again in another case a few years later.

A New York Times analysis of enforcement actions during the last 15 years found at least 51 cases in which 19 Wall Street firms had broken antifraud laws they had agreed never to breach. . . .

The pattern of repeated accusations of securities law violations adds another layer of concerns about enforcing the law. Not only does the S.E.C. fail to catch many instances of wrongdoing, which may be unavoidable, given its resources, but when it is on the case, financial firms often pay a relatively small price.

All this laxity toward Wall Street is especially outrageous given the trend toward harsher punishments elsewhere. Twenty-five states have adopted some version of "three strikes" laws since 1990s -- laws that can lead to life imprisonment in some cases for repeat offenders.

I have said it before and I'll say it again: The biggest hypocriscy around the mantra of "personal responsibility" is that this concept has rarely been applied to the privileged in our society. Instead, for some strange reason, we have held the most disadvantaged members of society to the highest -- and harshest -- standards while letting the wealthy get away with nearly anything.

Let's hope that senators Grassley and Reed can make our legal system just a tad fairer with their legislation.