Never Forget That "Country Wide Home Loans Is On Your Side"

Financial Fraud Is Focus of Attack by Prosecutors


By DAVID SEGAL
Published: March 11, 2009
Spurred by rising public anger, federal and state investigators are preparing for a surge of prosecutions of financial fraud.

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Matthew Cavanaugh/European Pressphoto Agency
Attorney General Eric H. Holder Jr. addressed state attorneys general on his antifraud efforts.
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Times Topics: Credit Crisis — The Essentials

Across the country, attorneys general have already begun indicting dozens of loan processors, mortgage brokers and bank officers. Last week alone, there were guilty pleas in Minnesota, Delaware, North Carolina and Connecticut and sentences in Florida and Vermont — all stemming from home loan scams.

With the Obama administration focused on stabilizing the banks and restoring confidence in the stock market, it has said little about federal civil or criminal charges. But its proposed budget contains hints that it will add to this weight of litigation, including money for more F.B.I. agents to investigate mortgage fraud and white-collar crime, and a 13 percent raise for the Securities and Exchange Commission.

Officials at the Justice Department have not said much in public about their plans. But people who have met with Attorney General Eric H. Holder Jr. say he is weighing a range of strategies.

“It’s clear that he and other top-level members of the Obama administration want to seize the opportunity to send a message of zero tolerance for mortgage fraud,” said Connecticut’s attorney general, Richard Blumenthal, who attended a meeting with Mr. Holder and other state attorneys general last week in Washington. “The only question is when and how they will do it.”

One person who had discussed the matter with Mr. Holder, but declined to be identified because he was not authorized to speak for the Justice Department, said that the attorney general was deciding whether to form a task force to centralize the effort or allow state attorneys general to develop cases on their own.

A Justice Department spokesman, Matthew A. Miller, would not comment, other than to write by e-mail, “It will be a top priority of the Justice Department to hold accountable executives who have engaged in fraudulent activities.”

At the low end of the mortgage transaction ladder, state prosecutors have had a relatively easy time prevailing, but recent history suggests that the government’s odds of winning drop when they go after Wall Street executives. Some high-profile convictions have been won in the last decade, but several of the Enron-related prosecutions and some cases brought by Eliot Spitzer when he was New York’s attorney general fell apart or were overturned on appeal.

As federal authorities decide on a course of action, Congress is becoming impatient. Representative Barney Frank, chairman of the House Financial Services Committee, announced plans last week for a hearing on March 20, inviting Mr. Holder, bank regulators and leaders of the S.E.C. to answer questions about their enforcement plans.

“Rules don’t work if people have no fear of them,” Mr. Frank, Democrat of Massachusetts, said. State and local prosecutors, it seems, do not need the nudge. Last week, the district attorney’s office in Brooklyn announced the creation of a real estate fraud unit, with 12 employees and a mandate to “address the recent flood of mortgage fraud cases plaguing New Yorkers.” In late February, Maryland unveiled a mortgage fraud task force, bringing together 17 agencies to streamline investigations.

With all the state activity and portents of a new resolve at the federal level, lawyers who defend white-collar clients sense growing momentum to perp walk and prosecute executives involved in the mortgage crisis.

“It’s going to be open season,” says Daniel M. Petrocelli, a lawyer whose clients include Jeffrey K. Skilling, the former chief executive of Enron. “You’ll see a lot of indictments down the road, and you’ll see a lot of prosecutions that rely on vague theories of ‘deprivation of honest services.’ “

Many financial executives have hired lawyers in the last few months, either through internal counsels or, more discreetly, on their own, several lawyers who defend white-collar clients said.

While assorted Wall Street executives have been prosecuted over the years, any concerted legal attack on the financial sector would have little precedent. After the Depression, Congress formed what became known as the Pecora Commission, which grilled top financiers. But the point was mostly to embarrass them, and the upshot was to set the stage for stricter regulations. The most indelible image of the commission’s hearings was a photo of J. P. Morgan Jr. with a midget who had been plopped in his lap by an opportunistic publicist.

The question behind any cases brought against Wall Street will boil down to this: Was the worst economic crisis in decades caused by law-breaking or some terrible, but noncriminal, mix of greed, naïveté and blunders? The challenge for the Obama administration will be to prove that it was the former, said Michael F. Buchanan, a partner at Jenner & Block and a former United States attorney in New Jersey.

“We punish people for intentional misconduct, we don’t punish them for stupidity or innocent mistakes,” he said. “If you’re a prosecutor, you want evidence that shows real dishonesty. You want something that shows that these people were doing something wrong, and they knew it.”

That nearly all of the banking industry acted the same, possibly reckless, way could actually help any executive who lands in court, lawyers said. The herdlike behavior suggested that bankers were competing for business using widely shared assumptions, rather than trying to get away with a crime. It would be hard to prove that anyone broke the rules, these lawyers said, since regulations in the riskiest parts of the mortgage industry were so lax.

One defense lawyer said he expected to argue that either his clients did not understand the financial instruments they were marketing, or were not warned of the dangers by underlings.

“We’ll all sing the stupidity song,” said the lawyer, who said he feared that speaking publicly by name would deter potential clients. “We’ll all sing the ‘These guys never told me’ song.“

But for government lawyers, the environment for corporate fraud cases could scarcely be more inviting. It is not just that the public’s zeal for Wall Street pelts is high. The resources are there, too, because some of the money once used to fight terrorism is being shifted to fighting financial fraud. And in recent years the use of wire fraud statutes has expanded, allowing prosecutors to turn virtually anything said or sent by e-mail in private into a federal crime, if it contradicts what investors were told in public disclosures.

Wire fraud charges were among those against two former Bear Stearns managers who were arrested in June, accused of praising their hedge fund to clients as they worried about it to colleagues. Federal sentencing guidelines also link the length of a prison term to the size of the financial loss to the public. Given that so many billions have vaporized recently, convictions could easily lead to life sentences, defense lawyers said, and the mere threat of such sentences gives prosecutors enormous leverage in settlement talks.

“There are executives now getting sentences longer than murderers and rapists,” said Mr. Petrocelli, the lawyer, referring to white-collar prosecutions in recent years, including that of Mr. Skilling of Enron, who is now serving a 24-year sentence for securities fraud and other crimes.

Why has there not been a batch of subpoenas at the federal level already? The Department of Justice is missing important staff members, says Reid H. Weingarten, a defense lawyer and former trial lawyer for the Justice Department. Former members of the Justice Department say that prosecutors and regulators are reluctant to act while the markets are in such disarray for fear of further unnerving investors and the public.

Lawyers for white-collar clients say they expect to be busy, but not all of them predict that means they will be earning huge fees. In the past, the legal bills of Wall Street higher-ups were paid by insurers that indemnified them. But that is not necessarily the case with banks that have gone bankrupt or disappeared.

“I know bankers are not now evoking much sympathy from the public at large,” Mr. Weingarten said. “But these days many Wall Street types are struggling mightily with mortgage payments, tuition bills and health insurance. It’s a very different world out there now.”


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