Much is being made in the USA of Senator Elizabeth "Fauxcahontas" Warren's inaugural session of the Senate Banking Committee where she grilled the SEC:
Sen. Elizabeth Warren from Massachusetts made federal regulators uncomfortable when she asked a simple question: When was the last time you took a big Wall Street bank all the way to trial?Cue much applause by those who think that the "big Wall Street banks" get away with too much. Perhaps, though, Sen. Warren may be playing to the peanut gallery rather than actually making the financial industry behave better. Here's why.
A more thorough consideration of the SEC's actions at The New Republic points to a rather fundamental problem: winning financial misconduct trials turns out to be quite difficult.
While federal prosecutors recently won a landmark insider trading case to put top executives behind bars, fraud can be harder to prove. In 2009, a jury acquitted two former Bear Stearns bankers the government charged with deceiving investors about the risks associated with CDOs, complex securities manufactured from packages of mortgage loans. The SEC, in fact, has yet to convict anyone in court on charges related to causing the financial crisis.This is a manifestation of a fundamental rule: going to court is almost always a bad idea. Going to court means that there is an asymmetric assessment of the situation. The prosecutor believes that the defendant has done something bad and has to pay; what's more, he has the evidence to demonstrate this, and he believes it sufficient to convince a jury (or judge, depending on the trial) of the defendant's guilt. Further, he believes that the penalty that the judge will award is substantially greater than that which the defendant is willing to pay pre-trial.
By contrast, the defendant must believe that the facts of the situation will be unlikely to convince the judge or jury of her guilt. The defendant has already heard the prosecution's allegations and will know what evidence she has turned over to the prosecution, and the defendant's lawyers will be at least as familiar with the relevant laws as the prosecution; thus, she will have a realistic assessment of what the prosecution can prove. If there's a reasonable chance of conviction, the defendant's best strategy by far is to negotiate a settlement with the prosecution based on the median penalty for the alleged offences; it's way cheaper than conducting a trial, let alone paying an inflated penalty. For this reason, banks are generally better advised to settle with the SEC even if they don't believe what they did was wrong - if the penalty is bearable, it's preferable to the expense and risk of a trial let alone all the negative public exposure.
I think it's reasonable to claim that the SEC's competence in financial regulation and enforcement is, at best, limited. They attract lawyers and administrators who are satisfied with government salaries and working conditions. Their staff members prefer porn surfing to working and are allowed to get away with it. They need a case to be a slam-dunk in order to proceed to prosecution with a reasonable chance of success - yet, a slam-dunk case should have the defence scrambling to negotiate a settlement pre-trial. If they don't settle, they're either idiots - possible, but unlikely given the target crowd of Wall Street corporate lawyers - or they have a very different assessment of the case, and likely the evidence or legal precedent to back it up.
If the SEC is forced to take more cases to trial, there are two likely outcomes. One is for the prosecution to be successful (a slam-dunk case) but the penalty to be not much more than the defendant offered to pay, in which case the prosecution (SEC) still has to pay its own legal fees and so the public purse is hit harder. The other is for the prosecution to fail, or be forced to negotiate a lesser charge, in which case the defence pays less than they originally offered and the prosecution pays its own legal fees and possibly also some of the defence's; the public purse in this case is hit much harder. Either way, there is little chance that the banks will be hit harder beyond having to pay their trial costs, and the SEC's trial costs will also rise sharply. And who benefits from trial cost spending?
If the SEC takes more cases to court, the only people who will benefit will be the lawyers. And what did Sen. Warren do before she became a senator this year? She was an academic lawyer, specialising in bankruptcy protection. It appears that she is very aware of which side her profession's bread is buttered.