One of the most important financial regulators in America just announced his new plan for reining in white-collar crime. It doesn't look good.
A pair of traders share a laugh on the New York Stock Exchange floor, Tuesday Sept. 30, 2008. AP Photo/Richard Drew
Nobody would look at how the government handled white-collar fraud cases after the financial crisis, when big bankers who sent the economy into chaos escaped criminal charges and often got promoted, and see some kind of model. Nobody, that is, except for James McDonald, the new enforcement chief at the Commodity Futures Trading Commission (CFTC), an obscure US agency that oversees the $483 trillion derivatives market.
In a Monday night speech in New York City, McDonald announced a new initiative to provide significant benefits to financial institutions that "self-report" crimes and cooperate with investigators. In exchange, he said, companies might see civil penalties slashed, and in some instances, cases dropped altogether. A former federal prosecutor, McDonald noted the idea originated in gang prosecutions—he's done a lot of those—where it made sense to let individuals report on higher-level colleagues in exchange for leniency.
"We're committed to giving companies and individuals the right incentives to voluntarily comply with the law in the first place—and to look for misconduct and report it to us when they see it," McDonald said, according to an official transcript.
In a vacuum, this initiative doesn't sound that bad. McDonald seems to be committing his agency to real police work: going up the chain to find the highest-level individual who can be prosecuted for wrongdoing. And only those companies disclosing all known facts and continuing to actively investigate—including rooting out those responsible—would be eligible for a reduced fine. Oh, and they would have to make sure the misconduct didn't happen again, either.
Plus, McDonald pointed out, this is just how things work in America. "One goal in advancing our self-reporting and cooperation program is to bring ours in line with our law enforcement partners," including the Department of Justice, he said.
That's true. It's also a huge problem.
Many white-collar crime investigations in the US actually take place largely within the offending companies themselves. The rise of the "internal investigation" dates back to the 1970s, when the Securities and Exchange Commission (SEC) decided it would be more cost-effective to let companies do the work of rooting out fraud for them. Corporate law firms and third-party auditors gather facts on their clients and present them to law enforcement, and companies get brownie points for playing ball.
As you might expect, this can make prosecutors overly dependent on whatever companies choose to give them. "Setting up an enforcement regime based on cooperation and compliance hurt the government's ability to conduct investigations on its own," Jesse Eisinger writes in his book The Chickenshit Club: Why the Justice Department Fails to Prosecute Executives. "Prosecutorial skills erode. The government has outsourced and privatized work—to the misbehaving corporations themselves."
Just look at the financial crisis that tanked the global economy starting in 2007 and 2008 for evidence of how this can play out. Self-reporting incentives didn't exactly push the banking industry to stick to the rules: When mortgage and foreclosure abuses began to emerge in 2010, banks promised to cooperate. Except the resulting investigations were almost nonexistent—prosecutors went quickly to no-fault settlements instead of charging banks or individuals who ruined lives. Banks expected to get off simply by promising never to do it again, and they were right. "If there's one thing we should have learned from the experience of the last decade," said former congressman and financial reform advocate Brad Miller, "it's that we can't count on an honour system to regulate Wall Street."
In fact, in the wake of the crisis, the Justice Department changed its own rules on cooperation, deciding that a corporation could only get credit if they offered up every single person responsible for the misconduct in question. This amounted to an admission of failure—that the way the DOJ interpreted the rules inevitably led to banks getting away with the white-collar equivalent of murder.
Now the CFTC—which regulates some of the most dangerous financial products on the planet—is borrowing the Justice Department's new and slightly improved formula. There's little reason to think such an approach will save us from the next financial catastrophe.
After all, the CFTC has long depended on banks policing themselves because they have no capacity to do the job otherwise. "They're always reliant on self-reporting because they are insanely under-funded," said Marcus Stanley, policy director at Americans for Financial Reform, a pro-regulatory coalition. The annual operating budget for the agency is $250 million, a number that has remained flat for three years. For context, the information technology budget just at JPMorgan Chase—one of the world's four traditionally dominant derivatives traders—was $9.5 billion last year.
While CFTC brought in $1.29 billion in enforcement actions in fiscal year 2016, it is barred by law from keeping a dime for its own budget. That makes it completely dependent on Congress for sufficient resources to combat fraud. Those resources never appear, making proper oversight impossible. Under the 2010 Dodd-Frank financial reform law, CFTC was instructed to—for the first time—keep watch on all derivatives trades, theoretically bringing an international shadow market into the open. But without the staff or even the data capacity to do so, the agency is basically just watching from the sidelines. The last enforcement chief, David Meister, admitted he didn't file charges against JPMorgan Chase traders in the notorious "London Whale" case because of a lack of funds.
"Despite all the caterwauling from Wall Street about CFTC's tough enforcement, there's reason to believe a lot of manipulation in commodities markets goes undetected and unpunished," Miller, the former US congressman, told me. The agency already has to hope that the industry it regulates willingly cops to misconduct. The only difference now is that if and when Wall Street guys do come forward to offer a narrow window into their industry's wrongdoing, they can expect a more generous windfall in the form of reliably reduced penalties.
That this system is already extremely generous to derivatives traders doesn't mean they're not complaining anyway. A New York Times report this week teasing the new CFTC policy noted industry executives called the Libor case, when over a dozen banks were caught rigging a critical global interest rate, "regulatory overkill" on the agency's part. "The industry thinks Libor manipulation was blown out of proportion? Really?" Miller gawked. "What's their idea of a really big deal if jiggling the world's benchmark interest rate isn't?"
It's hard to expect this kind of self-reporting regime won't be abused in the Trump era. Regulatory agencies are already bringing in significantly less in enforcement fines since Inauguration Day. And the head of the CFTC, J. Christopher Giancarlo, was himself a former executive in GFI Group, a company whose derivatives arm was fined more $2 million for colluding with other companies to fix rates for brokerage services. GFI then bought out another firm, Phoenix Partners, whose own brokers were found to have engaged in similar misconduct. Which is to say there's good reason to suspect McDonald's new boss isn't totally committed to high ethical standards in the industry they're supposed to be regulating.
There's a place for self-reporting to help police shady industries, especially by allowing whistleblowers to report misbehaviour at the top. And McDonald, the CFTC regulator, was adamant in his speech that "this won't amount to a 'get out of jail free' card." But the long American story of cozy arrangements like this one inevitably puts the industry in charge of the jail, making sure their own executives stay out.
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