Thursday, September 29, 2016

Fraud in Selling Sub-Prime Mortgage-Based Bonds: Beyond Accountability

“In December 2011, the S.E.C. publicized its civil securities fraud charges against top executives from Fannie Mae and Freddie Mac for understating their exposure to subprime mortgages, which resulted in the government taking them over.”[1] Robert Khuzami, then the head of the S.E.C.’s enforcement division, said at the time that “all individuals, regardless of their rank or position, will be held accountable for perpetuating half-truths or misrepresentations about matters materially important to the interest of our country’s investors.”[2] Pursuing even senior ranks has the air of fairness economically as well as in terms of the dictum, no one is above the law. So much for words; how about the accompanying deeds?

According to The New York Times, “Five of the executives settled in 2015 by arranging for modest payments to be made on their behalf by the companies and their insurers, amounts that were never even described as penalties in the settlements. Each also agreed not to hold a position in a public company that would require signing a filing on its behalf for up to two years.”[3] Payments made “on their behalf” means that the money did not come out of their pockets. As for being barred, “(t)hat is far short of the director and officer bar the S.E.C. usually seeks in such cases, but at least it had the sound of something punitive regardless of whether there was any real impact.”[4] I submit that such a sound is insufficient to count as real accountability.

Fast-forward to August 22, 2016: On that date, the Securities and Exchange Commission settled its last remaining case. The charge against Daniel H. Mudd, a former chief executive of Fannie Mae, was related to the insufficient disclosure of the company’s subprime mortgage exposure. Again, the SEC “accepted a mere token payment that will not even come out of the individual’s own pocket.”[5] Fannie agreed to make a $100,000 donation on Mudd’s behalf to the U.S. Treasury Department—a payment that both put the department in a conflict of interest and enabled Mudd to avoid sacrificing any of his own wealth. Curiously, there was to be no ban on him holding an executive position at another public company, “something that at least resulted from the cases against the other executives.”[6] So, incredibly, the S.E.C.’s enforcement results had become more dilute. In short, the former CEO was able to keep his compensation even though the fraud took place under his watch. So much for deterrence and accountability.

Moreover, “(W)hat the S.E.C. accomplished in settling the cases against Mudd and the other executives hardly sends a message to other executives to be careful about how they act in the future. No money came out of the pockets of any of the defendants, and the prohibitions on future activity were token requirements.”[7] Also on August 22nd, “a federal appeals court refused to reconsider its May ruling that Bank of America’s Countrywide mortgage unit and one of its former executives did not commit fraud by failing to disclose to Fannie Mae and Freddie Mac that the subprime loans it was selling to them did not come close to the contractual requirements for such transactions.”[8] It seems, therefore, that financially and organizationally senior managers would get the message that millions of dollars in compensation are not subject to civil accountability. In other words, the fortunes would continue to come as a sort of entitlement, come hell or high water. The price in terms of systemic risk could be through the roof.



[1] Peter Henning, “Prosecution of Financial Crisis Fraud Ends With a Whimper,” The New York Times, August 29, 2016.
[2] Ibid.
[3] Ibid.
[4] Ibid.
[5] Ibid.
[6] Ibid.
[7] Ibid.
[8] Ibid.