The U.S. Securities and Exchange Commission’s case against Citigroup’s Brian Stoker, a director in the bank’s Global Markets group, seemed clear-cut. Stoker structured and marketed an investment portfolio consisting of credit default swaps. The agency accused him of misrepresenting deal terms and defrauding investors for not disclosing the bank’s bet against the portfolio while pitching the investment vehicle to customers. But when it came to trial earlier this summer, the government could not prove that Stoker knew or should have known that the pitches were misleading, and the jury didn’t convict.
It’s hardly surprising. The SEC’s failure to secure a guilty verdict is one more sign that the commission still has not climbed out of the morass in which it was mired for most of the Bush years. The agency tasked with overseeing some 5,000 broker-dealers, 10,000 investor-advisers, 10,000 hedge funds, and 12,000 public companies, as well as mutual funds, the exchanges and even the rating agencies, is ailing because of outdated rules, systems and structures.
What exactly ails the SEC? For starters, the legal framework in place to prosecute securities fraud is flawed. The commission was established to create rules that prohibit “any manipulative or deceptive device or contrivance.” But intent or recklessness is required to prove fraud or misrepresentation, and that can be difficult because the agency doesn’t have enough staff to comb through reams of documents for rare evidence that someone intended to cheat. In the Citigroup case, the agency instead relied on a rule that simply required a showing of negligence, but the prosecution could not prove even that.
The Stoker case underscores the legal framework’s penchant for punishing midlevel managers rather than those in charge. As the foreman told the American Lawyer, the jury could not find Stoker liable because “he did not act in some kind of vacuum where his behavior was not tolerated or encouraged by his bosses … To try to hang all this on Stoker didn’t work.” But the government rarely goes after higher-ups or CEOs like Dick Fuld and Jon Corzine because they are removed from day-to-day operations and often don’t leave evidence of intent or negligence. It faced this conundrum while building the case involving the Abacus deal that led to a $550 million settlement with Goldman Sachs and will have to overcome the same hurdle when former Goldman Sachs trader Fabrice Tourre is tried for his role in that deal.
Even so, accountability for wrongdoing can be fleeting because the agency still collects significantly less money from people as opposed to institutions. As a result, shareholders of corporate entities often get penalized financially for the deeds of midlevel managers and advisers. While this is changing, there still is a culture of punishing institutions, rather than wrongdoers. U.S. District Judge Jed Rakoff has been a vocal critic of this approach. In November, he refused to approve an SEC settlement with Citigroup that allowed the bank to “neither admit nor deny” wrongdoing. While the U.S. Court of Appeals for the Second Circuit likely will approve the settlement, in January the SEC stopped allowing wrongdoers who settle with the SEC and also are criminally convicted to “neither admit nor deny” charges.