To hear Eric H. Holder Jr. tell it, the Justice Department is aggressively cracking down on financial fraud.
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U.S. Attorney General Eric Holder
On Monday in Washington, Mr. Holder, the United States attorney general, announced with much fanfare the results of a new enforcement program: Operation Broken Trust. “With this operation, the Financial Fraud Enforcement Task Force is sending a strong message,” Mr. Holder declared, highlighting the Ponzi schemes, affinity frauds and investment scams his department had prosecuted.
In all, Mr. Holder said his new task force had brought cases against 343 criminal defendants and 189 civil defendants for fraud schemes that harmed more than 120,000 victims throughout the country, involving more than $8 billion in estimated losses.
It all sounded quite important, and the program’s slogan is pretty catchy. But after you get past the pandering sound bites, a question comes to mind: is anyone in the corner offices of Wall Street’s biggest firms or corporate America’s biggest companies paying any attention to Mr. Holder’s “strong message”?
Of course not. (I actually called some chief executives after Mr. Holder’s news conference, and not one had heard of Operation Broken Trust.)
That’s because in the two years since the peak of the financial crisis, the government has not brought one criminal case against a big-time corporate official of any sort.
Instead, inexplicably, prosecutors are busy chasing small-timers: penny-stock frauds, a husband-and-wife team charged in an insider trading case and mini-Ponzi schemes.
“They will pick on minor misdemeanors by individual market participants,” said David Einhorn, the hedge fund manager who was among the Cassandras before the financial crisis. To Mr. Einhorn, the government is “not willing to take on significant misbehavior by sizable” firms. “But since there have been almost no big prosecutions, there’s very little evidence that it has stopped bad actors from behaving badly.”
That is not to suggest that the government should not enforce the law just because certain crimes are smaller than others. The markets won’t work unless the public believes that the playing field is level and that someone is enforcing the rules.
But fraud at big corporations surely dwarfs by orders of magnitude the shareholders’ losses of $8 billion that Mr. Holder highlighted. If the government spent half the time trying to ferret out fraud at major companies that it does tracking pump-and-dump schemes, we might have been able to stop the financial crisis, or at least we’d have a fighting chance at stopping the next one.
Shawn J. Chen, a partner in the Washington office of Cleary Gottlieb Steen & Hamilton, called the announcement by Mr. Holder “a public relations push more than anything else.” Mr. Chen went so far as to suggest that the number of cases Mr. Holder cited as evidence of the department’s crackdown were somewhat fictional.
“It’s hard to believe that they built up all these cases in the past four months,” since the task force was created, Mr. Chen said, suggesting it was more likely that Mr. Holder counted every case that had anything to do with financial fraud and put them all under the Operation Broken Trust umbrella.
At the moment, by the looks of the headlines, the government’s next big crackdown will be insider trading cases at hedge funds. The government is bringing to bear all its resources, including the F.B.I., which is using wiretaps and raiding offices. But when in recent years have you heard of such maneuvers used on the chief executive of a major corporation?
For those wondering why the government seems to have studiously avoided taking on big companies, I stumbled on a novel theory worth sharing.
Mr. Einhorn, who had his own run-ins with the government when he tried to reveal fraud at Allied Capital and wrote about them in his book, “Fooling Some of the People All of the Time,” says he believes the government consciously and strategically does not pursue cases against big companies and officers.
His theory is intriguing. Any case against a big company or officer, he says, inherently “penalizes the shareholders.” And the shareholders are the “little guys” whom the government is supposedly seeking to protect. Mr. Einhorn makes a good point. While the public lusts for the hanging of a corporate executive, the shareholders would also most likely take the big hit in the wallet.
To Mr. Einhorn, however, the government’s approach means shareholders look the other way instead of raising red flags themselves.
He said: “The problem with trying to give existing shareholders a free ride on whatever’s going on” — that’s what he argues the government is doing — “is that it takes away the incentive for existing shareholders to be worried when they see management misbehaving. It would be a much stronger, self-reinforcing, positive system if when shareholders saw management misbehaving, they were incentivized to call up management and say, ‘Please stop misbehaving or something bad is going to happen to my investment.’
“Instead, what they do, implicitly, is encourage the further misbehavior.”
He may be taking his theory a bit too far, but he says he believes the government’s strategy, if you want to call it that, stems from “an embedded belief that they did the wrong thing with Enron and with Arthur Andersen — the criminal prosecution, particularly of Andersen.”
Of course, Mr. Holder and the Justice Department do not agree with Mr. Einhorn’s assessment.
But, ultimately, Mr. Holder’s Operation Broken Trust should be as much about restoring faith in the markets as it is in the government’s ability to police them properly.