Why I (Belatedly) Blew the Whistle on the SEC’s Failure to Properly Investigate Goldman Sachs

By James A. Kidney

The New Yorker and Pro Publica websites today posted an article by Pro Publica’s Jesse Eisinger about the de minimis investigation by the Securities and Exchange Commission into the conduct of Goldman Sachs in the sale of derivatives based on mortgage-backed securities during the run-up to the Great Recession of 2008.  The details of the SEC’s failure to aggressively pursue Goldman in the particular investigation, Abacus, and its refusal to investigate fully misconduct by Goldman and other “Too Big to Fail” banks, stands not only as a historic misstep by the SEC and its Division of Enforcement, but undermines the claim that the Obama Administration has been “tough on Wall Street.”  The Pro Publica version contains links to a few of the documents I provided.

SEC sealNo one in authority who was involved in the Goldman investigation ever gave me an explanation for why the effort was so slight.  Mr. Eisinger’s article doesn’t offer any explanation from the one investigation participant brave enough to comment.  The details of the investigation into Abacus at my level as trial counsel, which I provided to Pro Publica earlier this year, compels the conclusion that the SEC, its chairman at the time, Mary Schapiro, and the leadership of the Division of Enforcement were more interested in a quick public relations hit than in pursuing a thorough investigation of Goldman, Bank of America, Citibank, JP Morgan and other large Wall Street firms.

Although the emails and documents I produced to Pro Publica stemming from my role as the designated (later replaced) trial attorney for the Division of Enforcement are excruciatingly boring to all but the most dedicated securities lawyer, even a lay person can observe that the Division of Enforcement was more anxious to publicize a quick lawsuit than to follow the trail of clues as far up the chain-of-command at Goldman as the evidence warranted.  Serious consideration also never was given to fraud theories in any of the Big Bank cases stemming from the Great Recession that would better tell the story of how investors were defrauded and who was responsible, due either to dereliction or design.

Instead, the SEC restricted its investigation to the narrowest theory of liability, had to be pressed (by me) to go even one short rung above the lowest level Goldman supervisor in its investigation (which took months to push through, though investigative subpoenas are frequently issued on far less in far smaller cases) and finally dropped other investigations of Goldman in return for a $550 million settlement announced July 15, 2010.  To my knowledge (I retired in March 2014), the SEC never again pursued Goldman for its mortgage securities fraud or other major fraud.  There is no evidence on the SEC website that it did so.

Nearly six years later, long after the statute of limitations for securities fraud expired and individuals, pension funds and corporate entities are no longer able to bring private actions against the Big Banks, the Department of Justice announced another settlement with Goldman for its deceptive conduct in the sale of mortgage-backed securities.  In this one, Goldman agreed to pay more than $5 billion “in connection with its sale of residential mortgage-backed securities.”

At a minimum, it can be said that the SEC left 90 percent of the money on the table at a time when a more aggressive investigation of the company, as well as others, could have counted for something by disclosing, in a detailed court complaint, Wall Street wrongs that might have helped policy makers better address the subject and allow damaged individuals and entities to bring their own lawsuits.

It is very important to emphasize emphatically several points.  First, I have zero evidence, and would be very surprised, if any of the individuals at the Division of Enforcement, including senior supervisors or the SEC chairman or associate commissioners, acted unlawfully or were motivated principally to protect Goldman and other big banks.  All of these people appeared well-intentioned from their point of view, even they never really explained, to me, or to many others at the Commission, their motives in limiting investigations.  The most senior level supervisors left more lucrative jobs in the private sector to head the Division of Enforcement, taking plum jobs but at significant personal sacrifice. (They then returned to even more lucrative employment or even more high-profile public positions.)  All of them were gentlemen.  These factors make it all the more surprising that I never got a clear answer as to why the investigation was so constipated, as it obviously was.  Its range was clearly limited from the outset:  we will sue the bank and not look hard for evidence of individual participation beyond the lowest levels.

By the same token, it is unfair to assume as a fact that any of the individuals at Goldman not sued, or anyone at Paulson & Co., violated the securities laws, civilly or criminally.  Like any citizen, they are entitled to a day in court.  Absent such opportunity, they are innocent of any wrongdoing.  Arguments in my internal correspondence that evidence was sufficient to sue should be viewed only as that — arguments.

So my point in releasing these documents to Pro Publica is not to chastise or hold up to public criticism those involved at the SEC, Paulson & Co. or Goldman, though criticism of the process and of the underlying financial conduct certainly is inevitable.  All of these institutions have substantial influence in the investment industry.  Rather, it is to bring to light the actual conduct of one of several SEC investigations into Big Bank fraud leading up to the 2008 financial crisis.

As I told Mr. Eisinger when I met him, I hoped he would go to the individuals in charge of the SEC investigation at the time and find out why the investigation was so limited. I have spent six years wondering what is the true answer to that question.  Perhaps there were sound reasons, other than the urge to get out a quick press release, which led experienced criminal prosecutors with histories in Wall Street to smother a major investigation by limiting it to the lowest level employee possible, to express total resistance to even investigating further up the chain of command, and ignoring without serious explanation and analysis what I and others, including my own immediate supervisors, viewed as the more appropriate theory for civil prosecution.  I hope there are such reasons.  As a  trial attorney at the SEC for over 20 years, I bled SEC blue.  I believed that the agency usually tried to do the best it could, using analog era procedures and processes to combat fraud in a digital age.  I am saddened to release this information.  But the notion that “the Administration was tough on Wall Street” must be addressed by facts, not press releases and self-serving interviews, else the system’s problems cannot be adequately addressed and repaired to deal with the next financial crisis.

Not only is the issue of how the financial sector enforcement agencies handled the wrongs of the Great Recession an important political issue, but it is important to history.  It is important that the facts not be shielded from the public so that we can all learn for the future.  And it is a melancholy thought that, presented with the opportunity for a rigorous investigation and airing of facts in civil or criminal proceedings gone, history will be denied a fairer story of both the financial crisis itself and how the government responded.

goldman_sachs_logo_doorAs many news organizations have noted, the taxpayer and Goldman shareholders will pay the combination of penalties and repayments in the DOJ settlement.  No individual was named as liable in the civil settlement with Goldman nor in any of the other similar, and even larger, financial settlements entered into with the Department of Justice, all of which are vastly greater than what the SEC obtained in its “quick hit, one and done” enforcement actions.  DOJ must be credited with what appears to have been a far more thorough investigation of wrongdoing than the SEC performed, but the public is properly mystified that no individuals were charged, criminally or civilly, although the DOJ press releases contains the usual caveat that “the investigation continues.”

The settlements with Goldman and other Big Banks were resolved under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), which allows the Feds to ignore the normal five-year statute of limitations for fraud, but does not permit suit by private party victims.  As has been the practice with DOJ when dealing with Wall Street, no criminal charge was brought.  In fact, no complaint was filed in any of these cases.  Instead, DOJ entered into contractual arrangements with the banks.  Failing to fulfill their obligations under the contract would subject them to civil enforcement as a breach of contract matter, not a contempt charge in federal District Court.

Contrary to claims by politicians, it is clear that the Obama Administration has not been hard-hitting on Wall Street fraudsters.  The large fines obtained by the Department of Justice, while a short-term pinch, are simply a cost of doing business.  Relying on fines to penalize rich Wall Street banks, which, after all, specialize in making money and do it well, if not always honestly, is like fining Campbell Soup in chicken broth.  It costs something, but doesn’t change anything in the way of operations or personnel.

Despite billions in fines representing many more billions in fraud, the enforcement agencies of the United States have been unable to find anyone responsible criminally or civilly for this huge business misconduct other than a janitor or two at the lowest rung of the companies.  Nor have they sought to impose systemic changes to these banks to prevent similar frauds from happening again.

Yessir, according to the Obama administration, Goldman Sachs, JP Morgan, Bank of America, Citibank and other institutions made their contributions to tearing down the economy, but no one was responsible.  They are ghost companies.  And nothing needs to be done to prevent such intent or dereliction in the future.

Law enforcement by contract?  Clearly, the banks made it a condition of settlement that no complaint, civil or criminal, be filed.  That might gum up the works by requiring state regulators to take action under their own rules, or cause other collateral consequences.

Ah, say the defenders of the status quo, don’t forget about Dodd-Frank, the unwieldy legislation passed by feckless Democrats influenced by big money contributors and their own fear of appearing too aggressive (a particular Democratic Party contagion).  Dodd-Frank was and is a virtual chum pool for Wall Street lawyers and lobbyists, leaving most of the substance to regulatory agencies such as the SEC and the Federal Reserve, who for years have been significantly captured by those they are supposed to regulate.  The private sector lawyers and lobbyists have open doors to these places to “help” write the rules and add complexity, which they later complain about in court, challenging those same rules as too complex.

Dear citizen, just remember this:  complexity favors fraud, and certainly favors Wall Street and corporate America.  You can’t understand the rules and neither can Congress or all but the most dedicated experts.  That’s a lot of room to disguise misdeeds.  To take a current example, which came to my attention just before completing this post, Congress is trying to use sentencing reform, generally thought of as intending to remove inequities from the criminal justice system, to also make it even tougher to prosecute and punish white-collar crime.  Is this why the Koch Brothers suddenly show such public attention to the poor and needy by favoring such legislation?  See this discussion of adding the “mens rea” requirement to such legislation.  Burying an important but legalistic issue in otherwise liberal leaning legislation is a current example of disguising lax enforcement of white-collar crime in a complicated package.  As one Democratic congressman suggested, how can a liberal vote against sentencing reform?  The explanation of the badger buried in the woodpile is too complicated for the average voter.

Not coincidentally, adding a requirement to the law that it is a defense to either the crime itself or to sentencing that “I didn’t know my acts were against the law” is a get out of jail free card as the complexity of laws addressed to ever more sophisticated business misconduct grows.  Wall Street clearly has shown no shame in using the defense that “no one knew”.  Can’t blame them.  It has worked so far.  Maybe they don’t even need new legislation.

I was told repeatedly when I entered the Goldman investigation that synthetic CDOs were just too complex for me to understand.  Of course, it appeared to be plain vanilla fraud selling a product designed to fail but nicely packaged for chumps to buy.  Claims of complexity hide many easily understood sins.

At least for the major sins, we don’t need even more complex regulations.  Instead, put leadership in place who will aggressively enforce the laws we have already.  That would raise plenty of eyebrows and put some bums in prison, or at least make them pay civil and criminal penalties personally.  As many have noted, prison or, at least, personal financial liability, beats corporate concessions every time and pays back in future reluctance to break the law.  The country should try it sometime.

So back to little me, a small and ineffective cog in the larger system.  Why is this release of documents so long after the investigation?

My friends know that I have been upset since 2010 about the way the SEC handled the Goldman case and, in my view (confirmed by other trial lawyers), that it became a template for other SEC civil suits against the Big Banks.  In 2011 I wrote an anonymous letter to The New York Times complaining about the lack of investigative effort by the Division of Enforcement and the impact of the “revolving door” bringing Wall Street defense lawyers into the highest reaches of the SEC.  This is a practice that Obama has continued at most departments and agencies having to do with the financial system, following in Bill Clinton’s footsteps.  The New York Times letter was based entirely on publicly available information.

I was dismayed to not find any follow-up to my letter in The New York Times.  I gave up trying to bring attention to the investigative lassitude of the agency.  Interest appeared to be over.

A year after I retired, I sent a copy of the letter to The Times, under a cover letter identifying myself.  One of the addressees on the original letter called and told me  the original letter never was received.  The caller suggested that was because I misaddressed it to the old location of The New York Times.  I felt foolish, of course, but I guess that in 2014, when the letter was finally received, The Times didn’t see fit to follow-up the information even knowing its source.  This was another indication to me that the time for debate over the law enforcement treatment of wrong doers on Wall Street had passed.

Once, years earlier and only for a brief time, the SEC was an agency that was at least sometimes fearless of Wall Street institutions.   In those days, the directors of the Division of Enforcement were home-grown, not imported from Wall Street law firms.  After 1996, that ended.  Every director since has been nurtured as a Wall Street defense lawyer.  The decline in performance has followed an expected arc.  No one has seemed bothered by this.   It seems the phrase “lawyers represent client interests” is sufficient explanation to insulate this practice from critics.  In this view (pushed by lawyers), lawyers are the only people in America who are not influenced by their work experience, including friendships and defense of client practices.  They are SO exceptional!  So give it up, Jim, I finally told myself.  It’s the nature of Washington to put foxes in hen houses and claim they are protecting the fowl.

But in April 2015, Sen. Bernie Sanders announced his presidential candidacy, based principally on anger over how Wall Street has escaped being held seriously responsible for its misdeeds. If you credit Sanders with nothing else, praise him for not letting go of the notion of justice for those who suffered and those who caused pain and anger for millions.  Yes, the banks are not solely responsible for the Great Recession, but they contributed more than their fair share and leveraged immensely the damage initially caused by others.

Sanders was not treated seriously.  The publications I read made it clear that Sanders was, like Donald Trump, a flash in the pan.  Jeb Bush and Hillary Clinton would be nominated.  Anger against Wall Street and inequality were issues, but not worthy vehicles for a political campaign.  Nothing here.  Move on.

It turns out that the ravages caused by Wall Street are the gift that keeps on giving.  As Sanders campaigned with far more success than predicted, and Secretary of State Clinton defended President Obama as “tough on Wall Street,” it was evident that my small contribution to correcting the record might be timely.

So here it is.

Do I think Obama is responsible for the ineffective and embarrassing lay downs at the SEC and DOJ?  Yes, I do.  I have no idea if the President communicated to his law enforcement appointees that they should “go easy on Wall Street.”  Rarely is such overt instruction necessary in Washington.  But it is not hard to believe that in some fashion he did send such signals, since he came into office with a mantra of letting bygones be bygones, including in the far more important arena of the false narratives for invading Iraq.

In any event, the chairman of the SEC and the attorney general are appointed by the President.  At a minimum, we can say with certainty that Obama was satisfied with their performance. It is difficult to conceive that, as a Harvard educated lawyer who also taught law at the University of Chicago, it never crossed his mind how massive civil or criminal misconduct could go on without the supervision or knowledge of at least mid-level executives. Certainly, the public criticism was brought to his attention.  His response was to create a joint task force on the subject of fraud in general.  Its main visible public function is to collect all the press releases on fraud prosecutions, including small-time fraud, on one website.  It also offers advice to “elders” on how to avoid fraudulent scams.  The pro forma mention of the task force in DOJ’s announcement of the Goldman settlement signals that the Task Force doesn’t do much.  Again, law enforcement by press release.

The alternative possibility, never mentioned because it is preposterous, is that big Wall Street firms so lack supervision of their lower level employees that fraud on a huge scale can be conducted without the knowledge of even mid-level executives.  At the SEC, at least, such a conclusion should call for application of its “regulatory” function to impose supervisory conditions on the banks.  No such action was ever undertaken.  Instead, it was “pay up some money and nevermind.”

Dodd-Frank at best imposes generalized rules about bank size and other generic issues, rather than addressing the kinds of fraudulent actions that actually occurred.  It is appropriate for the SEC or Federal Reserve to impose narrower changes in corporate practice to address specific kinds of fraud.  They are called “undertakings” and are often imposed by civil settlements with the SEC or in litigated relief. It did not happen with the Big Bank frauds.

I believe that the American public is entitled to accurate information about how their government works, including the important regulatory agencies.  One way to do this is to fully disclose how the sausage is made, especially when the process is defective.  Self-promoting press releases swallowed by a fawning business press is not sufficient.  I knew I would not disclose any non-public information about the Goldman investigation while the lawsuit against Fabrice Tourre was pending.  He was the one guy at Goldman the SEC sued personally.  In fact, I think he was the only guy employed by any of the big banks sued personally.  (Another fellow who worked with the banks — not for the banks — was sued in another case.  He was found not liable, with the jury asking how come higher-ups were not in the dock and urging the investigation to continue. It wasn’t.) The Tourre case concluded a few years ago with a verdict against the defendant.  All appeals are exhausted.  The statute of limitations has expired for private actions. Disclosure of the information I had can do no harm to the public or to pending litigation.

The only reason to keep the information secret is to prevent embarrassment to the SEC or to those people who made decisions for the agency.  Most of them left the SEC years ago.  For public consumption, I have tried to redact all names of the non-supervisory personnel in the Division of Enforcement who worked on Goldman.  I also must add that, as the emails show, for a period of time those dedicated investigators were excited about the notion of bringing at least a slightly broader action than their supervisors wanted.  As is the case with much of the Division of Enforcement, the worker bees try hard and usually are fearless.  It is their bosses who frequently suppress their enthusiasm for policy, political, or personal reasons.

As final egotistical end note, I must say that, despite all of my personal reservations about his dedication to effective law enforcement in the financial sector, I voted for the President twice.  I will vote for whoever is the Democratic nominee.  But I ask myself:  Is this the best that two political parties given de facto monopoly over selection of presidential candidates can do?

Whoever is nominated and elected, Republican or Democrat, I hope that he or she will recognize the need to end the practice of hiring Wall Street personnel to run our financial enforcement agencies.  They should begin by looking to home-trained personnel to lead the major departments and agencies, such as Treasury, the SEC and the Department of Justice, including the chief of the Antitrust Division.  These are the people who are responsible for these institutions on a daily basis and also understand the nature and importance of their mission.  They have a career stake in doing an effective job.  Outsiders are, in general, more interested in resume polishing for the next private job.  Additionally, much great talent leaves these agencies for their own more lucrative private careers when they see their own chances for advancement blocked by outsiders or their energies trying to fairly but aggressively enforce the law sapped by timid leadership.

One party has chastised our government on every occasion for nearly 40 years  and shows no intention of reining in Big Business or Wall Street.  Directly or by implication, these attacks tarnish government employees in general, making a public service career less attractive to our most talented citizens.  The other party has been indifferent or ineffective in its defense of civil service and has addressed financial sector wrongs by adding to the complexity of the system rather than cutting through it.  As a result, some of our businesses are above the law.

Something has got to change.  It will.  The question is, will it be for the better?

3 thoughts on “Why I (Belatedly) Blew the Whistle on the SEC’s Failure to Properly Investigate Goldman Sachs

  1. What would happened if a CEO of a major bank had been comitted for fraud? Would the bank lose it’s charter? When the government was a major investor of the banks, what would have happened to the investment if there were felony convictions of bank management?

  2. Very courageous, and I’m sure difficult on many levels to come out like this — thanks for trying to enlighten us.

    “Mr. Eisinger’s article doesn’t offer any explanation…” This begs the question why Jesse Eisinger, who has been a rare and important bulldog chasing these issues for years, couldn’t find anything more specific to write about this.

    Don’t get me wrong, I do believe that investigation and punishment by the regulators has been inexplicably lax, if not purposely compromised. The report by the Financial Crisis Inquiry Commission was extraordinarily damning in great detail, but it was apparently never used (or even read?) by the regulators as a template for asking the right questions.

    So we’re left with the one sad conclusion: that the upper (political) level of regulators is, in fact, captured by industry. Ugh,

    Is Bernie Sanders the only political leader who knows this, or is he simply the only one currently with a megaphone large enough to be heard? We’re a mess.

  3. Wow.

    Thanks for posting this. It hasn’t gotten wide distribution, but I did publish a history of all this in 2014 on Amazon, calling it Finance Monsters. After 25 years inside the specialty on both the sell side and buy side, I think you would enjoy it. I tried to keep it light, but did take the reader through all the complexity, with definitions. Call it Liar’s Poker by one of the people actually on the trading desk, not repeating stories heard from across the ocean, or in the case of The Big Short, repeating the self-serving version of events by one group among the malefactors. I hope you have the time to spend with it. Again, thanks for telling this important truth.

    Howard Hill

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