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Hard Target: Prosecute Wall Street for Misleading Investors

David Callahan

Preet Bharara, the U.S. Attorney prosecuting the insider trader cases, is quoted in a recent New Yorker article as saying that a lack of manpower was the reason that authorities hadn't prosecuted more people involved in the financial crisis: "If the well is dry," he said, "a thousand more people aren't going to get you water in that well." 

Of course, that's absurd. New evidence emerges nearly every day that the well is not dry and that numerous financial firms engaged in illegal behavior during the boom. In particular, there is plenty of evidence that firms misled investors about the quality or risks associated with mortgage-backed securites -- and that these lies had devastating effects as investors lost fortunes.

Last year, Goldman Sachs settled with the government for $550 million for failing to share damaging information about collateralized debt obligations it sold to clients even as it helped a hedge fund bet against the securities underlying those CDOs. And just last week, the government settled with J.P. Morgan in a similar case. Also last week, the SEC reached a $200 million settlement with the financial firm Morgan Keegan and Company, and two of employees, James C. Kelsoe Jr. and Joseph Thompson Weller, for misleading investors about the true value of mortgage-backed securities in five of its funds.

This week brings yet more revelations: According to the Wall Street Journal, the SEC is broadening their probe against Stifel Financial for pitching dubious CDOs to a school district in Wisconsin that lost tens of millions of dollars. "The districts were defrauded in these transactions and have spent nearly three years proving how and why," said C.J. Krawczyk, a Milwaukee lawyer representing the schools.

And just today, in the biggest news of all, Bank of America agreed to pay $8.5 billion for claims that its toxic subsidiary Countrywide pawned off billions in junk mortgages -- including infamous "liar loans" -- to investors. This claim, damning as it is, wasn't even brought by the government but clearly was based on powerful evidence of deception.

Oh, and don't forget the investigation by New York State Attorney General Eric Schneiderman of a number of banks which he suspects knew about the problems with mortgage-backed securities but kept pushing them on investors anyway.

It would seem that many of these cases are not very complicated. It's a crime to knowingly mislead investors about the quality of the securities or equities they are buying, or the risks associated with these investments. It's called fraud because the result is that people can lose their money just as surely as if they had been swindled by a con man.

The problem is that building an iron-clad criminal case to prove that intentional deception and fraud occurred is no easy thing. The government can do it, but it takes resources: prosecutors spent years and millions of dollars to win criminal convictions against Enron's Kenneth Lay and Jeffrey Skilling for misleading investors (which is what they were tried for; not the actual fraud at Enron). Given these difficulties, the government typically just settles with wrongdoers in a civil settlement -- in effect, meting out a slap on the wriste.

Beyond the recent settlements, the feds let Angelo Mozillo off last year with a $67 million settlement that represents a fraction of the fortune he made as one of the kingpins of the deceptive mortgage securitization industry.

The Morgan Keegan settlement attracted scant notice last week, but is indicative of how lenient the authorities are being on white collar criminals. According to the SEC's detailed account of wrongdoing at Morgan Keegan, the firm's executives -- and particularly James Kelsoe -- deliberately manipulated the pricing of its mortgaged-backed securities in a way that deceived investors of their real value as the market for these securities deteriorated in 2007. Kelsoe's punishment? He will pay a $500,000 fine and be barred from the securities industry. Shoplifters get harsher punishments than this -- e.g., actual prison time.

Why didn't authorities go after Kelsoe with criminal charges? Probably the same reason they didn't go after Mozillo or the executives at Goldman Sachs or JP Morgan: They weren't ready to expend huge resources on a trial.

Maybe now that Preet Bharara has finished trying Raj Rajaratnam for insider trading he can focus his time and energy on a well that is decidedly not dry.