The NewYorker recently published an interesting article, “Why the SEC Didn’t Hit Goldman Sachs Harder.” The article posits that the SEC let individual executives on Wall Street off the hook for securities fraud after the financial crisis. The article offers an example of this lack of aggressiveness: the SEC’s decision not to charge any high-level executives at Goldman Sachs despite an investigation into a questionable mortgage-backed securities deal between Goldman and John Paulson & Sons. The deal was called Abacus.
As a result of the SEC’s investigation into Abacus, Goldman Sachs paid a $550 million fine, and a low-level trader named Fabrice Tourre was charged with securities fraud. (He was found liable after a jury trial, had to pay $650,000 in fines and referred to himself in emails as the “Fabulous Fab,” leading to considerable social media notoriety.) None of Mr. Tourre’s superiors or any other Goldman executives were charged by the SEC.
In the article, the white hat is worn by a former SEC enforcement lawyer named James Kidney. At the time, Mr. Kidney pushed the enforcement division to bring charges against Goldman executives, particularly Jonathan Egol (Mr. Tourre’s supervisor). The black hat is worn by Reid Muoio, the head of the SEC team investigating mortgage-backed securities. Mr. Muoio decided against bringing charges against higher-level Goldman executives.
As the article says
Kidney, for his part, came to believe that the big banks had “captured” his agency—that is, that the S.E.C., which is charged with keeping financial institutions in line, had become overly cautious to the point of cowardice.. .
Kidney later explained to Muoio that he was pushing for a more assertive approach because he believed that the S.E.C. had grown too passive in its oversight of Wall Street. “The damage to the reputation of the [S.E.C.] in the last few years and the decline of the institution are very troubling to me,” he wrote.
The article is an interesting read, but I don’t agree with its central thesis with respect to this particular case. I confess that it does seem surprising that the SEC found only Mr. Tourre to charge, given the size of the fine paid by Goldman. So, the SEC may have been a little soft here. But its failure to charge Mr. Egol appears to be a result of the agency’s appropriate reluctance to bring charges against Goldman executives when there wasn’t enough evidence against them. Discretion is the better part of valor and all that.
The article contends that the SEC was not sufficiently aggressive because it did not interview Mr. Egol until near the end of the investigation. This may be true but (1) the SEC did interview him eventually, (2) the SEC issued him a Wells notice to respond to allegations of wrongdoing, and (3) it is standard practice to interview the top folks after you have finished fact-gathering, not interview them right out of the gate.
The SEC’s problem was that its evidence against upper-level Goldman executives was, in a word, weak. These executives did not communicate as often as lower-level employees by email, instead responding to an email with “LDL,” or “let’s discuss live.” It’s hard to pin wrongdoing on someone when there is no documentary evidence of it. Neither Mr. Tourre nor anyone else at Goldman seems to have pointed the finger at Mr. Egol. (Boy, it’s hard for the government to win cases when no one is willing to be a cooperating witness in return for leniency, huh?)
According to the article, the SEC’s case against Mr. Egol could only be based on his review of documents with misleading statements about Abacus.
Simply reviewing misleading documents, rather than directing their creation or disseminating them to others with the intent to defraud, is hardly the basis for a strong case. The SEC no doubt knew that. Deciding not to charge Mr. Egol with securities fraud when it could only prove that he had reviewed misleading documents was the right decision, not a sign of weakness.
Mr. Kidney apparently pushed within the SEC to charge Goldman executives under a theory of “scheme liability.” Under this theory of liability, the SEC can charge those who participate in the sale of financial products that are intended to deceive investors. Abacus arguably fell into this category.
The Goldman case pre-dated the Supreme Court’s 2011 decision in Janus Capital Group v. First Derivative Traders. In Janus, the Court narrowed the scope of scheme liability under Rule 10b-5(b), concluding that a person is liable under Rule 10b-5(b) for “mak[ing]” a false or misleading statement only if he had “ultimate authority” for that statement.
Of course, the SEC did not have the benefit of the Janus decision, but courts had already been questioning its broad applicability at the time. In fact, the Supreme Court had narrowed its application its 2008 decision, Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. The SEC knew that scheme liability was not the strongest theory under which to proceed against Mr. Egol.
It’s not often that I defend the SEC. Even as a defense attorney, it is hard to believe that after extracting a $550 million fine, the SEC charged only Mr. Tourre and no high-level executives. (It is worth noting that Goldman Sachs did not admit liability in the settlement.)
If the article’s recitation of facts is accurate, however, then the SEC made the right call. If the most damaging evidence the SEC had against Mr. Egol was that he merely reviewed the misleading statements, then that shouldn’t be enough to hold him liable for the entire Abacus scheme. The securities laws—even under scheme liability—require more. If they didn’t, then the SEC’s ability to hold executives liable for a company’s wrongdoing would be a steep and dangerous slope.