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Friday, December 16, 2011

The SEC and the Courts on Wall Street Settlements: A Role for Presidential Executive Leadership?

The SEC enforcement staff, including its chief, Robert Khuzami, decided to kick a gift horse in the mouth rather than to “take a lesson” and perhaps come out stronger for it. At issue was the rejection by U.S. District Judge Jed Rakoff of the SEC’s proposed $285 million settlement with Citigroup. In his ruling, Rakoff denounced the penalty as “pocket change” to the bank, which would not even have to admit to any wrongdoing. Investors duped into buying into a $1 billion deal called Class V Funding III had lost $700 million. Betting at the time of issue against half of the assets in the deal, Citigroup did not share knowledge of its hedge with the investors.

The reaction of the SEC staff in Khuzami’s department was simply to “put down their pencils” and wonder how they should go about arranging settlements with financial firms accused of misconduct before and during the financial crisis of 2008. The SEC “doesn’t know what to ask for anymore in the settlements,” one of the people familiar with the Citigroup settlement said. Rather than take the judge’s judgment to heart, Khuzami urged the five-person commission running the SEC to vote to approve an appeal, and they did so. Rather than take the less convenient course of insisting that the banks too big to fail that manipulated their own clients at least admit wrong-doing and reimburse the losses, Khuzami viewed the judge’s ruling as if it were a political obstacle to be obviated by asking an appellate court to ignore it. Given the political muscle that must surely go with Citigroup’s wealth, Khuzami could have been assuming that the bankers would see to it that sufficient pressure would plied on enough appellate judges to make the obstacle easily avoidable. In other words, Khuzami was likely assuming that Rakoff was a fluke, given Citi’s influence—perhaps even in the SEC itself.

Considering the power of regulated banks such as Citigroup, it is not unreasonable to expect the chief executive of the U.S. Government, the President of the United States, to deviate from his avocation of influencing legislation far beyond his minority role as a veto. Rather than spending so much time hitting the stump to get voters to 1) influence their representatives in the legislature and 2) re-elect him, the president could get involved in the question of whether the verdict would be appealed. Lest it be said that that would introduce politics into the mix, I would counter that politics were already very much in the mix both in terms of the five-person SEC vote and in Khuzami’s response to the ruling (i.e., as an obstacle rather than as something to incorporate into future settlement offers). I would even say that politics was involved in Treasury Secretary Tim Geithner’s blessing of the decision to appeal, and therefore also likely a factor in the president’s decision not to intervene. Citi (and one of its major stockholders) had been Geithner’s sponsor when he was chosen to be president of the New York Federal Reserve.

Politics might also have been involved in the timing of the SEC’s announcement on the day following the appeal decision that the agency was suing the former chief executives of Fannie Mae and Freddie Mac for misleading investors and Congress on the volume of subprime mortgages on the books. Khuzami made the announcement himself, and it was well-covered in the media. Lest the decision to appeal in order to save a settlement deemed by a judge as too friendly to a major Wall Street bank be viewed with lackluster by the public, the timing of the Fannie and Freddie announcement could be anticipated to quickly impose a perception of going after the bad guys—even if the two conveniently-demonized organizations had been taken over by the very government that was suing them. The public would not be likely to suspect a double-standard for private-sector, well-connected banks, such as Citigroup.

Regardless of the political connections of Wall Street banks, for the U.S. president to tell the public that Wall Street should be held accountable only to look the other way on the SEC’s appeal decision—perhaps with the stated reason that politics should not be involved—seems duplicitous at best. As the chief executive, the president has a legitimate superordinate role to play in overseeing the decisions in the agencies within the executive branch. For a chief executive to claim that he or she should not impose on a subordinate department is a good indication that a subterranean agenda is in play. Furthermore, such an excuse evinces a refusal to assume responsibility (see #2 above). Too accustomed to seeing presidents obsess over pending legislation and propose still more (and act as commander in chief as well as figure head), the American citizenry has nearly lost any appetite for holding its presidents accountable as the chief executive of the executive branch—which extends beyond the West Wing. In the case of the SEC’s decision, the president was doubtless not willing to overrule his Treasury Secretary for political reasons.

Rather than deciding to appeal the ruling, the SEC should have accepted—with the president’s (or Treasury Secretary’s) intervention if necessary—the judge’s feedback as valid. Given the power and “too big to fail” risk of financial institutions like Citigroup, the government regulators act recklessly in accepting a “pocket change” no-guilt settlement. In announcing the decision to appeal, Khuzami said Rakoff’s position was “at odds with decades of court decisions that have upheld similar settlements by federal and state agencies across the country.” Precedent for precedent’s sake could merely be a vote for the status quo that favors even the fraudulent on Wall Street. We cannot assume that the stream of past court decisions necessary warrant being kept.

Clearly, Khuzami believed that requiring wrongdoers on Wall Street to admit to the wrongdoing would backfire on the government. Requiring an admission of guilt from defendants “could in practical terms press the SEC to trial in many more instances, likely resulting in fewer cases overall and less money being returned to investors,” Khuzami said. Just because powerful banks have a lot of money and power to throw at a trial, however, does not mean that the U.S. Government should cower over in trepidation or try to out-maneuver an inconvenient ruling that can actually be useful. Had he kept to the judge’s ruling, Khuzami could have gone back to Citi to say that more would be needed to avert a trial. It would not be his own opinion, after all, and contrary to Khuzami’s view, a judge’s opinion is not just an opinion; it is a ruling.

As for the issue of money damages and the number of trials, Khuzami is missing the forest for a few trees. For the viability of the U.S. and global financial system (and economy), banks too big to fail should be held accountable. It is therefore worthwhile even going to trial and staying the course through any appeals fueled by the banks’ deep pockets. At the very least, establishing a few precedents in terms of seeing that justice is served might aid in the SEC’s credibility in negotiating settlements with teeth. Higher money damages would undoubtedly follow.

In short, it would appear that the staff at the SEC needs more of a public service mission in which they could feel that they are making a difference in standing up to real power. In other words, they are not sufficiently fighters for the public good—the viability of the financial system and the economy as a whole. Instead, they are too interested in taking the route that is most convenient in terms of fear and stasis. It is in this realm that the chief executive can and should lead, if indeed he has that fire in his belly.

Sources:

Jean Eaglesham and Suzanne Kapner, “SEC Cops Want to Fight U.S. Judge,” The Wall Street Journal, December 15, 2011. http://online.wsj.com/article/SB10001424052970204844504577098833058976236.html

David Hilzenrath, “SEC to Appeal Federal Judge’s Rejection of Citigroup Deal,” The Washington Post, December 15, 2011. http://www.washingtonpost.com/business/economy/sec-to-appeal-federal-judges-rejection-of-citigroup-deal/2011/12/15/gIQAiGWcwO_story.html?tid=sm_btn_tw

Chad Bray and Nick Timiraos, “SEC Sues Former Fannie, Freddie Executives,” The Wall Street Journal, December 16, 2011. http://online.wsj.com/article/SB10001424052970203733304577102310955780788.html

Thursday, December 15, 2011

Leadership in Europe: A Recipe for Reducing Legal Uncertainty

Concerning the legal environment of business, the lawyers who teach as full-time instructors in American business schools affirm that managers would rather have a challenging environment that they know than one that is characterized by headlines such as, “Legal Uncertainty Imperils EU Agreement.” At the E.U.’s parliament, which represents the E.U.’s citizens, the president of the European Council, Herman Van Rompuy, said in the wake of the agreement, “An intergovernmental treaty was not my first preference, nor that of . . . most of the member states . . . It will not be easy, also legally speaking. I count on everybody to be constructive, bearing in mind what is at stake.” Meanwhile, the Wall Street Journal was also reporting that investors were “largely dismissive” of the Council meeting  at which the extra-E.U. agreement on strengthening the enforcement mechanism of state deficit and debt limits had been reached at the end of the previous week. Alan Brown, chief investment officer at Schroders Investment Management, which had at the time almost $300 billion under management, said of the results of the Council meeting, “Yes, it was what I expected, and yes, I was disappointed.” Schroders was backing up this view with a modest bet against the euro. Relatedly, Barclays was forecasting the currency to fall from $1.30 on December 13, 2011 to $1.25 by June 2012. Besides the pessimism on the “intergovernmental treaty” as well as a possible increase of funds from the $500 billion cap on the agenda at a Council meeting in March 2012, the sheer uncertainty described by Van Rompuy lowers the value of the announced agreement and the outlook concerning the viability of the euro as well as the E.U. itself.



              Federalismus in Action: Jose Barosso of the E.U. Commission and Angela Merkel of Germany / NYT

The full essay is at "Essays on the E.U. Political Economy," available at Amazon.

Federalizing the Criminal Code: Racial Opportunity Costs

On December 13, 2011, a bipartisan group of legal experts told a panel of lawmakers in the U.S. House of Representatives that the federal criminal code had grown so large that U.S. citizens could not possibly keep up with it. “We ought to get rid of the old myth that you’re presumed to know the law,” Rep. John Conyers (D-Mich.) said. About 4,500 criminal statutes exist, according to Ed Meese, a former U.S. Attorney General under President Reagan. “This is in addition to over 300,000 other regulations that don’t appear in the federal code but nevertheless carry essentially criminal penalties including prison,” he said. “So the vast array of traps for the unwary that lurks out there in federal criminal law is more extensive than most people realize.” The Administrative Office of the U.S. Courts figures some 80,000 defendants are sentenced in federal court each year.
Back in the 1990s, Sandra Day O’Connor, then a justice of the U.S. Supreme Court, said at a small gathering, “Congress is acting like a state legislature.” She went on to point to all the crimes being federalized. I asked her why the Rehnquist Court had not applied the brakes to this breach of federalism. “Because it takes five,” she replied. In other words, not even the Rehnquist conservative majority, which had been responsible for the Morrison and Lopez rulings, was sufficient to arrest the ongoing political consolidation via the federalizing of criminal law.
In late 2011, Rep. F. James Sensenbrenner, chairman of the U.S. House Judiciary Committee’s panel on crime, introduced a bill that would reduce the federal criminal code by a third and define the level of criminal intent that is necessary to break the law. Laying aside the matter of Congress over-criminalizing society at the expense of liberty, and the related matter of the “micro-managing” mentality that is implied in a ceaseless desire to “mold” or control others by threatening penalties, federalism itself ought to be brought to bear on Sensenbrenner’s proposal.
Specifically, in addition to reducing the quantity of federal criminal statutes and regulations to that which the citizenry can reasonably be expected to digest, each statute and regulation should be either retained or thrown out on the basis of whether it falls within one of the enumerated powers of Congress. By “falls within,” I do not mean indirectly or by extension, as in the specious argument that an Iowa farmer’s home-grown wheat used solely by the farmer (and his family) is subject to the reach of the interstate commerce clause because if enough farmers grew wheat for their own consumption, the price of wheat transported between states would be impacted. The term expressly need not be used in the U.S. Constitution for it to be understood that the enumerated powers do not distend through sheer reasoning to preempt those powers reserved to the American republics or their residual powers. Wheat that never leaves Iowa cannot, by definition, be considered to be part of interstate commerce. I suspect that the same logic is being broken in Congressional efforts to federalize criminal law.
The U.S. Constitution clearly states that the police power resides with the states. Considering the abuses associated by state officials in implementing (or abusing) that power (e.g., California police pepper-spraying students to manipulate them off the sidewalk on a public university campus), the U.S. Government could shift from undercutting federalism by “federalizing” criminal law outside the enumerated powers to strengthening federalism by acting on a check against abusive state officials. In other words, federal criminal law could be primarily directed to the states (i.e., their officers), and to citizens secondarily and only within the powers enumerated for Congress. This approach is consistent with the confederal element that is retained in the broader notion of modern federalism (e.g., as applied in the U.S. and E.U.), while acknowledging that the general government also reaches to the citizenry directly (“direct effect”).
One example of the federal government attempting to check a systematic abuse of power by police in a state’s county is the three-year investigation by the civil rights division of the U.S. Department of Justice of the Maricopa County sheriff’s office in Arizona. The ensuing report found “a pervasive culture of discriminatory bias against Latinos” reaching Sheriff Joe Arpaio himself. Deputies are said to “target Latino drivers on the roadways and detain innocent Latinos in the community in their searches for illegal immigrants,” according to the New York Times. Such practices, according to the report, are in violation of the Fourth Amendment’s prohibition on unreasonable seizures. The report adds that Latinos have been systematically mistreated in the county jail. Besides the report, a separate federal grand jury investigation was underway as well, focusing on accusations of abuse of power by the sheriff department’s public corruption squad.
For its part, the Justice Department was urging the sheriff to cooperate with the federal government in turning his department around, or risk a lawsuit and the loss of millions of dollars in federal money. Even so, Arpaio “brushed off the criticism in a news conference as politically motivated,” according to the New York Times. He was particularly upset that the homeland security secretary, Janet Napolitano, a former Arizona governor, had announced that the federal government would no longer allow the sheriff’s deputies to check the immigration status of inmates in their custody. In reaction, the sheriff remarked, “This is a sad day for America as a whole.”
Besides the inherent impoussance of the Justice Department’s plan “to do cultural change” in a sheriff department that is headed by intransigence, the sheer time during which the alleged abuses had been allowed to continue (e.g., the report taking three years) bespeaks a woefully inadequate priority in the federal government to act as a real check on the states. To be sure, Arizona is a sovereign state with regard to its police power, and the federal government is obliged to respect that sovereignty. However, neither a government of a state nor of the union is free to violate the U.S. Constitution, which is the source of all of the governmental sovereignty that is in the federal system (characterized by dual sovereignty—split between two systems of government, that of the states and that of the union). So Arisona is not free to violate the Fourth Amendment, and the general government can legitimately provide a check, as judged by the judiciary. Therefore, rather than usurping state criminal law by federalizing criminal statues, Congress should go to work to give the federal government better tools with which to act as a check on sheriffs such as Arpaio. Generally speaking, there is more than enough for the Congress to do within its federal role without encroaching on federalism itself paradoxically by “federalizing” powers assigned to the several states. The latter activity involves an opportunity cost that I dare say the Latinos in Maricopa County doubtless do not appreciate.


Sources:
Gary Fields and John Emshwiller, “Criminal Code Is Overgrown, Legal Experts Tell Panel, Wall Street Journal, December 14, 2011. 
Marc Lacey, “U.S. Says Arizona Sheriff Shows Pervasive Bias Against Latinos,” The New York Times, December 16, 2011. 

Monday, December 12, 2011

The Visible Hand: Markets Forging a Stronger E.U.

Joschka Fischer, a former foreign minister of the state of Germany, said the agreement under which 17 state governments accept more oversight and control of their budgets by the European Union “was a big step, which was pushed on the Europeans by the markets.” Such pressure was necessary, given the conflict of interest bearing on state officials working at the federal level on a deal that would add a new competency to the E.U. “(I)n the end,” Fischer added, “the markets have limited the options of the political leaders, especially of Merkel, and pushed her into giving more support for the euro.” Giving more support for the euro meant giving more power to the E.U. at the expense of the state-level where Merkel has most of her power. From this vantage point (i.e., the power that state officials have at the E.U. level), it is amazing that the E.U. has been able to acquire any additional competencies.


The full essay is at "Essays on the E.U. Political Economy," available at Amazon.

Sunday, December 11, 2011

Carbon-Dioxide Emissions amid Global Warming: A Species’ Death-Wish

Global emissions of carbon dioxide from fossil-fuel burning rose 5.9 percent in 2010, the largest amount on record, according to an analysis released in early December, 2011 by the Global Carbon Project. According to the analysis as reported by the New York Times, “the increase, a half-billion extra tons of carbon pumped into the air, was almost certainly the largest absolute jump in any year since the Industrial Revolution, and the largest percentage increase since 2003.” 

The full essay is at "Carbon Emissions: A Species' Death-Wish."